WASHINGTON, D.C. (CNNMoney.com) -- A bold new proposal to combat foreclosures was unveiled in Washington on Thursday.
The plan, dubbed "Help Now," was floated by the National Community Reinvestment Coalition (NCRC), a nonprofit community advocacy group. It calls for the government to buy up at-risk loans, restructure the terms to make them affordable and sell the reworked loans back into the secondary market.
"I think the plan is commendable. It doesn't let the home owner off the hook," said economist Mark Zandi of Moody's Economy.com. "They still have to pay at least part of the debt."
Help Now aims to improve upon the efforts of Hope Now, the alliance of lenders, mortgage servicers, non-profit community advocacy groups and investors led by the Bush administration to help troubled borrowers stay in their homes.
The Help Now approach will be more effective because, according to NCRC CEO John Taylor, it will make it easier for lenders to rework the terms of troubled mortgages. Indeed, the NCRC worked closely with most of the major lenders participating in Hope Now, including Bank of America (BAC, Fortune 500), Wells Fargo (WFC, Fortune 500), Washington Mutual (WM, Fortune 500) and J.P. Morgan (JPM, Fortune 500), to create this proposal.
Even servicers that are already participating in Hope Now are afraid to rework loans, because doing so effectively violates the contract that lenders have with the investors who own their loan portfolios - often pension and hedge funds, as well as foreign investors.
Lenders remain reluctant to offer workouts despite the fact that the American Securitization Forum (ASF), which is a member of the Hope Now alliance and represents the investors, recently authorized lenders to do so, as long as it is in the best interests of the investors.
"Servicers are accountable to the investors, not the ASF," said Taylor. "But once the government owns the loans and tells them it's okay, then that clears the obstacle."
How it would work
Under this proposal, the government would allocate as much as $20 billion up front. It would use those funds to buy up mortgages from investors in a reverse-auction process, at prices below the face value of the loans. In a reverse auction, sellers compete against one another, slashing prices until a buyer - in this case the government - says yes to a deal.
Since the government would buy the mortgages at a discount, it can pass the savings on to the borrowers by reducing the mortgage balances by the same percentage as the discount.
So if a batch of loans was bought at a 30% discount, the government would be paying $70,000 for a $100,000 mortgage. The government would then modify the mortgage, reducing the outstanding balance to $70,000. That would mean a big drop in the monthly payments, which would help many borrowers keep their homes.
The new, reworked mortgages will be underwritten conservatively, with loan-to-value ratios of no more than 90%, said Taylor. And no loans would be made unless borrowers were judged capable of keeping up payments based on their credit score, income and other underwriting criteria. Default rates should be reasonably low.
There would undoubtedly still be some at-risk borrowers who cannot afford even the discounted mortgages.
In those cases, the loan balances would be reduced even more, to $50,000 perhaps, from $70,000. In return, the government would obtain a second lien, said Taylor, representing the difference between what the government paid for the loan and what it further reduced the balance to. These liens would only be repaid to the government when the home is sold or the borrower refinances the mortgage.
It will be an uphill battle for Help Now to win backing from policy makers. "The one who has to take this plan and run with it is [Treasury Secretary Hank] Paulson," said Taylor.
Paulson, however, has been an enthusiastic supporter of Hope Now, nearly to the exclusion of other proposals. And he has adamantly opposed spending government money on any "bail-out" plans. The NCRC idea would involve at least some seed money, and the second liens may not get repaid for years - if ever. That could add up to big bucks.
Still, after another 10 or 12 weeks of economic turmoil, this new plan may start to attract support, said Economy.com's Zandi. Compared to the hundreds of billions on the price tag of the recently passed economic stimulus plan, the NCRC proposal looks cheap.
"Besides," he said, "the cost of doing nothing is worse." To top of page
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