Tuesday, October 6, 2009

Mortgage Assistance for the Unemployed

Proposals for the government to provide temporary assistance making mortgage payments to the unemployed are gaining some traction.

In earlier posts on this blog, I have argued that the primary driver of foreclosures is negative equity (aka underwater) and that foreclosure prevention efforts are likely to be ineffective unless they involve principal reduction in some way (such as shared appreciation mortgages, where homeowners would share any appreciation at the time of a future sale with the government or lender who provided principal reduction in the past). Although there are reports that more lenders are now including principal reduction as part of modifications, it doesn't seem that principal reduction is politically viable as public policy.

The new proposals are based on the idea that preventable foreclosures have a "double trigger." 1. Homeowners must be underwater on their mortgage, and 2. a triggering event that reduces income such as job loss. Details vary, but the idea is that the unemployed would get a voucher towards their mortgage payment that is proportional to the loss in income or based on formula connected to the local real estate market conditions.

The idea is that this is very targeted assistance at the most preventable foreclosures. Deeply underwater homeowners (such as those who bought at the peak in the Valley with little down and are probably 50% underwater) are considered inevitable foreclosures.

I agree that this might be a plan that provides the most foreclosure prevention "bang for the buck," but I'm not sure it is the best plan for the economy or that it is equitable. For example, one problem in the real estate downturn is that households are trapped in their homes and less willing and able to relocate to find new employment. Do we want a policy that discourages the unemployed from moving to find employment?

Because I believe that foreclosure prevention is so critical to the Valley economy at the moment, I am inclined to support these proposals despite my reservations and preference for other mechanisms. To learn more, see this policy brief from the Boston Fed, an excerpt is below.

By this logic, the best way to prevent foreclosures is to offer borrowers significant but temporary assistance in paying their mortgages. Such assistance allows borrowers who are suffering adverse life events the chance to “get back on their feet” without having to give up their homes. Unfortunately, most foreclosure proposals today offer borrowers moderate but permanent assistance, through reductions in principal, interest, or both. These reductions are likely to be too small to do much good for many borrowers.

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