Mortgage Bail Outs Might Increase Risk Of More Foreclosures

Posted on June 20th, 2008 by hinson

There is a hue and cry pressurizing the government to be more effective in enforcing help measures for the foreclosure victims. But experts argue that some plans of mortgage bail out might increase the risk of more foreclosures.

The Congress is anxious to help over million house owners who are under the cloud of foreclosures but some plans might mire the situation further – do more harm than good. Rep. Barney Frank together with Sen. Chris Dodd wants the Federal Housing Administration (FHA) to guarantee loans up to $300 billion. For this the original lender has to reduce the principal and bring it down to 85% of the current market value of the property. Supporters of the scheme opine that those facing foreclosures will be able to escape from the impossible debt while the lenders too will benefit by getting something more than what they would have got by foreclosing. Furthermore by preventing 1.5 million foreclosures the dropping real estate market will halt since the already satiated market will not be flooded by more foreclosed units.

The critics however are strident in their point that it will reward irresponsible loan taking and place the penalty on the tax payers for the loss. The whole scheme goes against the grain of financial logic. These sentiments are echoed by Robert Shiller of Yale University who had long warned about the housing bubble. Earlier in the decade the bubble began to blow out of proportions with low interest rates encouraged by Federal Reserve and lax loan giving standards. The bubble has not yet run out of steam. Shiller points out that the prices jumped by 85% from 1997 and continued till the middle of 2006. Since then it has fallen by only 15%. In comparison to rents and income of families the houses prices are still out of balance. In short – prices will continue to fall until water finds its level.

If Shiller is right then it is not surprising that more borrowers are finding their loan amount greater than the value of the property. This will trigger off more foreclosures crowding into the shop shelves. In this backdrop the FHA will find itself saddled with a large number of loans backing houses that are worth less than the loan amount. The banks and the tax payers (equivalent to the government) will find themselves drowning in a sea of bad loans.