New Unemployment Benefit: Mortgage Payment Deferral?

According to Reuters, President Obama is considering ways to allow unemployed homeowners to skip or defer payments while they struggle to find new jobs. This would be the latest of the administration's ever-evolving efforts to prevent foreclosures and ease the housing market into a bottom. This attempt, however, would have some serious problems.

First, here's what Reuters is reporting:

The official told Reuters it was reasonable for policymakers to consider options for loan forbearance -- allowing borrowers to delay, defer or skip payments -- that are more effective than those currently available in the private sector.

Right, because banks and investors likely want their money, so generally don't have particularly generous deferral programs. Since unemployment now seems to be driving foreclosures more than the subprime problem, no one should be surprised that the administration seeks to staunch this newer source of bleeding.

It's not clear how the administration would structure a program like this, but it would almost have to involve a carrot to get banks and investors to go along. I suspect that taxpayers will somehow have to pay some or all of those payments that Obama seeks to defer. That money would probably come from the catch-all bank bailout fund.

Could it be done through a stick instead? Perhaps, but I doubt it. These days, fewer banks are obligated to follow the government's every whim, since many are beginning to pay back their bailout money. As a result, Obama trying to use his leverage in that manner would prove somewhat ineffective.

The only other possibility I can see would be some rather extreme legislation forcing banks to allow payment deferrals for the unemployed. Given the failure of cram-down legislation (which would have allowed bankruptcy judges to rewrite mortgages) last spring, Congress seems a little wary to harm the sanctity of contracts. I'm not convinced a measure like this would pass either.

The potential benefit of this measure is obvious: if it works, it could prevent foreclosures and help to stabilize the mortgage market. The problems with the measure, however, are significant. According to Reuters:

But the official said the idea, which is still evolving, was difficult from a policy perspective and carries potential hazards. It could help more people struggling with economic difficulty, but it also could create perverse incentives that distort the housing market, said the official, who did not want to speak on the record about internal administration debates.

I can't be sure what perverse incentives that official is referring to. Does he mean people will seek to get fired so they can defer their mortgage payments? That seems kind of absurd.

The logistics get ugly. How long do you allow deferrals for? If unemployment is likely to remain high for another six months, or a year, can you allow mortgage payment holidays to last that long? Maybe by perverse incentives, that source means that if the deferrals extended until employment is finally found, then people would have an incentive to remain unemployed. That's easily remedied with a time limit, however. But then you also face the problem of just deferring many foreclosures, instead of preventing them: once that time limit expires, those homeowners might still be unemployed and unable to make payments.

There are other problems as well. What happens if, once gaining employment again, a person's new job doesn't pay as well as the old one? The homeowner may no longer be able to afford that mortgage, resulting in foreclosure anyway. Given the kind of deep economic turmoil we're seeing, it's going to be very common to have people settling for jobs that don't pay as well as their old ones.

That's why, even if a measure like this might seem to help in the very short-term, I worry about what it means for the mid- to long-term. For the reasons I explained, a program Congress could stomach would not ultimately prevent most unemployment-related foreclosures anyway. Even if it helps a handful, it would merely delay the pain for most.

If you'd prefer spacing foreclosures out over a few years instead of ripping off the band-aid quickly, then this measure might make sense. Instead, I believe that the economy needs to realize all its losses before it can really move forward. That's why I'm especially skeptical of a measure like this.