If approved, the government would spend $24.4 billion to guarantee 2.2 million modified loans through the end of next year. The FDIC said government backing will make the lending industry more willing to modify loans because it will share any losses with mortgage companies that agree to refinance certain home loans if the borrower defaults again.
“We think it’s essential that we actually strike at the underlying cause of the problems in the financial markets,” said Michael Krimminger, special adviser for policy at the FDIC, according to the Washington Post. “We think it’s time to make a decisive difference in the housing markets on foreclosures.”
Even if a third of those borrowers default again, 1.5 million homes will still be saved from foreclosure, the Associated Press reported.
“Although foreclosures are costly to lenders, borrowers and communities, the pace of loan modifications continues to be extremely slow,” the FDIC said. “It is imperative to provide incentives to achieve a sufficient scale in loan modifications to stem the reductions in housing prices and rising foreclosures.”
The FDIC said it would pay mortgage servicers $1,000 to cover expenses for each loan modified to the required standards, and would promise to share up to half of losses incurred if a modified loan defaults.
Eligible borrowers would include those who have missed at least two monthly payments on loans for homes they live in. Servicers would be expected to lower those borrowers’ monthly payments to about 31 percent of the borrowers’ monthly income.
“The government is getting something in return for this, which is keeping these houses off the foreclosure rolls. Because these escalating foreclosures [are] creating more and more downward pressure on home prices, which is having a very negative impact on our economy,” FDIC chief Sheila Bair said on NPR Friday morning.
The plan could be funded from the U.S. Treasury’s $700 billion bailout program for the financial industry, Reuters reported. Most of the money used so far in the Troubled Asset Relief Program, or TARP, bailout program has been injected as capital into banks in hopes of unfreezing lending.
FDIC Chairman Sheila Bair, who spent weeks unsuccessfully lobbying Bush administration officials for the foreclosure prevention plan, unveiled her agency’s proposal two days after Treasury Secretary Henry Paulson dismissed the idea of the government underwriting failing home loans.
Paulson told reporters on Wednesday, “That (foreclosure plan) is a subsidy, or spending, program. The TARP was investment, not spending.”
The Treasury Department said Friday that it was aggressively searching for ways to reduce skyrocketing home foreclosures under the TARP plan.
“We continue to aggressively examine strategies to mitigate foreclosures and maximize loan modifications, which are a key part of working through the necessary housing correction and maintaining the strength of our communities,” Treasury Interim Assistant Secretary Neel Kashkari said in testimony prepared for delivery to a U.S. House of Representatives committee.
The estimated cost of the FDIC plan is based on the assumption that only one in three borrowers who get a modification will be unable to make the lower payments, but existing modification programs have not achieved that level of success, the Post reported. About 45 percent of borrowers who received loan modifications from mortgage companies last fall already have slipped back into default, according to a Credit Suisse research note.
FDIC officials say the comparison is misleading because the their plan would give borrowers a much better chance at success.
“Most of the modifications that have been done to date are not sustainable modifications,” said Richard Brown, the FDIC’s chief economist. He called them “repayment plans,” meaning that borrowers are getting a second chance but not a payment reduced to a level they can afford.
Unless the FDIC proposal receives the Treasury Department’s approval, it would have to either be approved by Congress or wait for review by the upcoming Obama administration, CNN reported.
In other lending news on Friday, mortgage giant Freddie Mac asked the federal government for the first $14 billion due under its federal bailout after it reported massive losses, but concern is mounting that government efforts to stabilize the mortgage giant and sister company Fannie Mae are likely to grow far more expensive than originally thought.
Freddie Mac said it lost $25 billion from July through September. As a result it was essentially broke, having its liabilities exceed its assets by $13.8 billion.