We Have Plenty of Tools to Fix Housing Mess. Let's Use Them

The news media has been filled recently with all sorts of contradictory information on the state of the housing and related mortgage crisis.  

The Commerce Department recently reported that new home sales increased 7.6% in May and reached the highest level in two years. The Case Shiller index has begun to show improvement with prices actually moving up in certain major markets. The annual State of the Nation's Housing report, recently issued by Harvard University's Joint Center for Housing Studies, contains all sorts of bullish news including increasing existing home sales, an uptick in residential construction, stabilizing prices in many areas, falling rental vacancy rates, etc.

On the other hand, one can just as readily find evidence of continuing gloom and doom in the housing markets. The New York Times, in a recent editorial entitled "Still Depressed After All These Years" laments that "As policy makers focus elsewhere, the housing market is at risk of further weakening." Financial analyst Barry Ritholtz recently reported in the The Washington Post that the foreclosure machinery, after being artificially held back during the devastating loan servicing mess of the past couple of years, is now back in high gear, with several million more homes due to hit the courthouse steps in the near term, suggesting further erosion in home values.  Robert Shiller of Yale University, a co-creator of the Case-Shiller index, has sounded another alarm suggesting that only with widespread collective action by policy makers can we hope to restore the housing market to normalcy.

I suspect that the contradictory nature of recent reports inevitably means that we have no clear, convincing trends in housing performance and that we are going to have to be patient until the weight of evidence is clearer. And while the Obama Administration has taken concrete steps to improve its various loan modification and refinancing programs, there is little or no realistic chance of any broad new initiatives which would require Congressional action.  As for Prof. Shiller's "collective action,” I’ve argued in previous articles that the broad scale reduction of mortgage balances is unrealistic and has already occupied entirely too much of the public discourse. There is simply no fair or equitable way to selectively reduce mortgage principal and to do so would encourage bad behavior, raising the issue of "moral hazard.”

At the same time, we see numerous examples of individual solutions to the ongoing crisis, no one of which is a panacea, but when taken together could contribute more than they are today.

Consider short sales, a practice of relieving the homeowner by having the lender agree to a sale and release of the debt for less than the full loan amount.  The lender must, of course, establish that the sale is taking place with an arm’s-length buyer and a fair market price, and that the seller does not have the resources to cover the deficiency.  Short sales are occurring with increasing frequency, but there is evidence in the market that the process is very cumbersome and that many short sales do not go to settlement because the buyer loses patience with the lengthy approval process. My research with the real estate community has shown that at least in the Washington metro area, loan servicers become bogged down with their own internal bureaucracy or in dealing with investors or mortgage insurers, a process which has been known to take six to eight months – even in cases where there is no suggestion that the seller is not dealing in a totally honest, straightforward manner.

Short sales can and should be a powerful force for long term improvement in the housing market, because they fairly relieve the seller from a mortgage obligation that is unaffordable, yet avoid "moral hazard" because the seller is giving up the property. Mortgage servicers can and should be required to adhere to strict time limits in the processing of short sales.

Secondly I find it quite amazing that, despite being strongly endorsed by the Federal Reserve white paper on the housing markets released earlier this year, very few lenders are availing themselves of the benefits of home leasing programs.  In the case of a homeowner who has a stable source of income, but not enough to service the mortgage debt, the problem is best resolved by having the lender take title to the property and lease it back to the former owner for a reasonable rate and term, rather than enduring all of the financial, social and community impact of another foreclosure and eviction. For some reason, portfolio lenders such as banks and thrift institutions seem unwilling to get into the "dirty" business of owning and leasing houses. Lenders must be willing to develop expertise in property management and leasing, but it’s not that difficult.  The country is loaded with competent builders and home improvement contractors who could be productively employed refurbishing excess housing inventory, to the overall benefit of the economy and the housing stock.  Rental rates are soaring in many parts of the country as we have become more a nation of renters than of homeowners and availability is scarce. Former President Clinton has even suggested that lenders could be given tax credits for qualified energy saving improvements, thereby helping our environment.

At Chevy Chase Bank, with the onset of the economic crisis, we immediately set up a formal residential leasing program which produced excellent results for everyone's benefit.  Regulators should take concrete steps to encourage the aggressive use of leasing programs, both to reduce foreclosures and to spread out the disposition of properties over time.

Thirdly, while the Administration's recent enhancements to its loan mod and refi programs is making a significant difference, particularly with loans held by Fannie Mae and Freddie Mac, it is important that all lenders and servicers "get on board" with the objective of enabling underwater borrowers to refinance and obtain the benefit of historically low interest rates.  Many national lenders are already experiencing significant refi volume increases, a highly positive development, but all lenders, large and small, must join this effort.

We have all read stories of how struggling borrowers with high fixed rate loans cannot refinance because their loan-to-value ratio exceeds 100%, often by a substantial amount.  Lenders must realize they already have the risk of the underwater loan, they are not increasing that risk in any way, and, in fact, the borrower is logically and statistically more likely to keep his mortgage loan current if his monthly payment is reduced to the current low rates.  

The same flexibility should apply to the issue of credit scores. The Wall Street Journal recently reported that in 2011, 90% of the mortgage loans originated nationwide were made to borrowers with a FICO score of over 700.  In 2007, the comparable percentage was approximately 50%.  Undoubtedly, the 50% figure in 2007, a time of reckless mortgage lending, was too low. But, at the same time, with credit scores nationally averaging around 675, the 90% figure in 2011 was clearly too high. It is a national imperative that lenders recognize that the pendulum may have swung too far in the direction of underwriting stringency, and that for the benefit of the overall economy and ultimately their portfolios, clear, logical reasoning is called for.

So while opinions vary as to whether or not we have hit the bottom in the housing and mortgage markets, and there are clearly no easy answers to these problems which took many years to build up, there is ample evidence that much more could be done to more fully exploit known, proven contributors to the resolution process. Let's not leave any stone unturned as we collectively work to end this crisis as soon as possible.

Alexander R. M. Boyle is the retired vice chairman of Chevy Chase Bank. He has worked in mortgage lending and consumer banking for 30 years.