Reviving the Home Owners' Loan Corp.

At a recent seminar at the Aspen Institute I was intrigued and impressed by a proposal of Stuart Brafman, a retired executive from the mortgage insurance industry and a regional director of the Office of Thrift Supervision during the S&L crisis. He applauded the Obama administration's plan to avoid mortgage foreclosures, but argued that a revived Depression-era initiative needed to be put in place to cope with the still-significant number of foreclosures that would happen regardless. He has written the idea up for American Banker magazine [you need to register to get a free trial].

Though the Obama administration's foreclosure prevention plan promises to help some homeowners meet their mortgage payments, many foreclosures are still expected from borrowers who fall outside the plan or who default despite receiving financial assistance. These foreclosures will impede the real estate market's recovery, which economists agree is necessary for the economy to rebound.

Meanwhile, families should not have to agonize over relocating when the foreclosed property's early sale is unlikely. It is best for the borrower to remain in the house, because vacant properties attract vandals, deteriorate more rapidly and promote neighborhood degradation.

There is a way to stem the tide of foreclosures while generating cash for lenders to make new loans and to enhance capital.

Simply put, the government should step in and purchase from lenders, at a discount, properties underlying mortgages that are about to be foreclosed. This is a new twist on a program that worked during the Great Depression.

A government agency should be organized for the mortgage rescue. It might be named the Mortgage Recovery Corp. The MRC would agree to purchase homes securing the defaulted mortgage for 80% of the dwellings' current, fair market value. A participating lender would be required to complete the foreclosure, thereby wiping out the borrower's interest and all secondary liens, and deliver marketable title to the MRC. The borrower would not be evicted in the process.

The borrower could elect to stay in the house as a tenant. The rent paid to the MRC would be 25% of the household's gross income, even if it is nominal. That amount is a time-honored, prudent benchmark for family housing expense. The tenant would have the opportunity, but not the legal right, to repurchase the residence at its then fair market value before the government sells it to another party, provided the tenant is occupying the home and the rent is current.

Lenders should be willing participants, because they are unlikely to recover more than 80% of a mortgaged property's value net of the costs for loss of interest, maintenance, taxes, repairs and brokerage commission. Furthermore, a lender could recover as much or more from the MRC immediately instead of waging a prolonged sales effort in a severely depressed market. The up-front cash proceeds could be promptly reinvested in new loans to qualified borrowers, which would stimulate the economy. The new financing would improve a lender's earnings and capital position. Finally, the costly overhead associated with administering a portfolio of foreclosed, vacant houses in a declining market could be avoided.

The whole piece is well worth reading.