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Frank's Foreclosure Prevention Plan

April 25, 2008 - by Donny Shaw

Barney Frank (D-MA) has an interesting plan to prevent some potential foreclosures. He wants to let the Federal Housing Administration (FHA) step in and work out new mutually-beneficial deals between struggling homeowners, mortgage lenders and the government. The plan, also known as the FHA Housing Stabilization and Homeownership Retention Act, was approved yesterday by the House Financial Service Committee, and is likely going to be a central element in Congress’s package of housing stimulus proposals that is beginning to shape up.

Frank’s bill would create a new program within the FHA to give out new, government-backed loans with sensible repayment plans to homeowners who are at risk of defaulting on their current mortgages. The bill would limit the amount of outstanding loans the FHA can refinance to $300 billion. Here are the details on how the refinancing would work, as provided by the House Financial Services Committee:

>In exchange for the acceptance of a substantial write-down of principal, the existing lender or mortgage holder who chooses to participate would receive a “short payment” (i.e. a payment for less than the outstanding balance as payment in full) from the proceeds of a new FHA-guaranteed loan if the new loan would have terms that the borrower can reasonably be expected to pay and the borrower agrees to share future home appreciation with the government. In short, the program would provide refinancing assistance to allow families to stay in their homes, protect neighborhoods and help stabilize the housing market.
>Under the program, a borrower or existing loan servicer of an eligible loan would contact an FHA-approved lender, who would determine the size of a loan that would be consistent with the requirements of the program and that the borrower could reasonably repay. If the current lender or mortgage holder agrees to a write-down that is sufficient to meet the requirements of the program and make the new loan affordable, the FHA-lender will pay off the discounted existing mortgage.
>In addition to a first lien, the government will retain a share of future home-price appreciation to help defray the government’s costs and prevent unjust enrichment (e.g., borrower flipping). When the borrower sells the home or refinances the loan, the borrower will pay from any profits the higher of (1) an ongoing exit fee equal to 3 percent of the original FHA loan balance; or (2) a declining percentage of any profits (e.g., from 100 percent in year one to 20 percent in year five and 0 thereafter). After year five only the 3 percent exit fee will apply from borrower profits.

See the Financial Service Committee page for a list of eligibility requirements for both existing loans and the new FHA loans. Also, see Calculated Risk for an examination the whole plan in more detail

The big question about this bill is whether or not it will come as a cost to taxpayers. Because FHA loans are backed by the government, if a borrower of one of the new FHA loans were to default taxpayers may be the ones paying it back. But, as Dana Chasin of OMB Watch points out, “taxpayers also might not be on the hook for a penny — and, in fact, the federal government might ultimately make a pretty penny in the process under the plan.” Truth is, nobody knows, and we’ll have no reasonable guess to go off of until the Congressional Budget Office (CBO) finishes up their analysis of the bill. Frank’s initial estimate is that “it will have an ultimate cost between 1 and 2 percent of this $300 billion authorization.”

The administration is skeptical of the proposal. U.S. Treasury Secretary Henry Paulson seems to think it’s a decent idea, saying that “there are not huge differences” between Frank’s bill and a relaxation of FHA rules that the administration has already put into effect. However, the Department of Housing and Urban Development recently came out strongly against Frank’s bill. In a letter (pdf) to Frank, Roy Bernardi, the current Acting HUD Secretary, wrote:

>With regard to H.R. 5830, the bill is an overly prescriptive attempt to legislate FHA’s underwriting standards in a way that would force the agency and taxpayers to take on excessive risk and would jeopardize its stability. The bill’s design would significantly limit lender participation, and the reliance on a new Oversight Board would add another layer of bureaucracy and delay any of the bill’s purported benefits. Furthermore, unlike the Administration’s, this legislation may come at a cost to taxpayers who are not participating in the new program. An attempt to shift costs to taxpayers would constitute a bailout. For all these reasons, the Administration strongly opposes H.R. 5830.

Notice, there has been no formal veto threat issued yet. Both sides, the administration and Democrats in Congress, are jockeying for position right now, trying to make sure they can get some of their priorities passed in the housing package. Here’s Frank’s guess of how this may play out:

>He said there’s a good chance that his FHA refinancing proposal would be combined in a package with tax provisions, legislation to reform so-called government sponsored enterprises and another bill to modernize the FHA. The latter two are things the White House very much wants done.
>That might help the administration hold its nose and take the whole package.
>“The administration doesn’t like some parts of it, but likes other parts – it would be a genuine kind of compromise,” Frank said.
>“So while the administration says now that they don’t like this particular bill, it may get packaged into a number of other things they like.”
>He predicted a “strong possibility” of such a package moving in May.

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