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The Mortgages Mess is Worse Than You Think -- But There are Promising Solutions

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As 2010 is getting ready to wrap up, I remain pretty worried about the prospects for 2011. I just don't see evidence that a strong economic recovery is ready to take hold. Job growth still looks anemic and waves of foreclosures continue to sweep across large swaths of the country. Currently, one in every 100 homes is in foreclosure proceedings, and one in four homes is underwater, meaning the owners owe more on their mortgages than they are worth on the market. There are estimates that 10 million more families will lose their homes before the end of 2012. It looks like there's plenty of hardship ahead for families caught up in the economic downturn and the bursting of the housing bubble.

As with the jobs scenario, the future of the housing market is filled with uncertainty. It is impacting families, communities, and unfortunately continues to threaten the health of the broader economy. And it is unlikely that rising housing prices will provide any relief--because in most markets housing prices should remain stagnant if they don't fall further. For all these reasons, the mortgage mess remains troubling and is in need of greater attention.

We focused on this issue yesterday at an excellent event at the New America Foundation organized by research fellow and American Prospect writer Tim Fernholz. The goal of the event was to explore the dynamics of the crisis and shed some sunlight on promising solutions.

On the problem side of the ledger, for a couple of reasons I left the event feeling a bit more sanguine than I was going in. First, the model of servicing mortgages that emerged when securitization took hold over the last 30 years is clearly broken. Even if the mortgage provider, the homeowner, and the local community would all be better off is a foreclosure was avoided and would renegotiate the terms of the deal if they could, foreclosures are structurally pushed along by the proverbial middleman (who was just supposed to be there to move paper and money around). Second, the robo-signer problem (where foreclosures executed without adequate review of documents) is real and dangerous. For starters, it calls into question title ownership, so some people are being kicked out of their homes illegally AND it raises the probabilities that a large number of mortgages have been erroneously included in the mortgaged-back securities that have been bought, sliced, diced, and sold throughout the world.

Judges and state attorney generals are beginning to dig into this issue in earnest. The subsequent financial fraud investigations may stop some future foreclosures from occurring but they also may force banks to take back the mortgage investments they previously sold, which would bring new losses to their already fragile balance sheets and create a new source of systemic risk. Yikes.

I am convinced more than ever that we need to slow down the pace and incidence of foreclosure. Not everyone should be entitled to stay in their home, of course, but in many cases writing down the principle of the mortgage and redoing the deal is by far the best outcome. We need to find ways to make this happen.

And the panel delivered the goods in identifying several concrete policies worth pursuing. Here's a short list:

Automatic mediation. Alon Cohen who has worked with the Center for American Progress described a reform to the foreclosure process which gets all the interested parties in a room to explore renegotiation. When people talk, they generally settle on terms that maximize their respective outcomes. In a nutshell, mediation works! Half the states already have a process in place to facilitate this but the process can be made more effective if it is inserted into the process automatically as a default. Some states are already doing this and getting impressive results. The next challenge is to get the other half of the states involved who are not promoting any mediation process.

Bankruptcy reform. I call this "cramdown" but Julia Gordon of the Center for Responsible Lending says "bankruptcy reform." Either way, the key is to allow judges the opportunity to get involved in modifying the loans of underwater mortgages. Currently, consumers behind on their credit obligations may file for bankruptcy to protect some of their assets, but primary mortgages are exempted. Given the scale of the housing crisis and the number of families facing foreclosure, bankruptcy judges should be empowered to reduce the principal and interest rate on home mortgages while increasing the duration of the loan. A proposal to allow these "cramdown" provisions passed the House in 2009 which would have reached an estimated 1 million households, only to die in the Senate. It should be reconsidered, especially in cases when a lender does not offer to modify the loan to reflect prevailing home values.

Get the servicers out of the driver's seat. Mike Konczal makes a very compelling case that the role of the servicers is relatively new and this was the first test of how they would perform when stressed. They are failing the test. The incentive structure of the process needs to be reworked so that loan modification is given a chance before a foreclosure proceeds.

Fund legal aid lawyers. These are the attorneys who have uncovered the robo-signer scandal and the title problems. They are pursuing innovative lawsuits and are representing beleaguered homeowners who need an advocate to stay in their homes. They don't charge the homeowner for their services and are paid low, no, or modest salaries. It turns out that a little bit of federal money can go a long way.

We should strive to give a bit more attention to these and other promising policies in the months ahead. This is an issue that deserves a much larger profile in 2011 than it has received in 2010.