Saving Our Homes: Plans to End the Subprime Crisis

More than a year into the subprime crisis, the mortgage industry hasn't shown any convincing signs of recovery. Politicians say that more needs to be done to help homeowners in distress, and they have some big ideas for action.

A little magic is cooking up on Capitol Hill. Following the lead of illusionists like David Copperfield and Lance Burton, U.S. politicians are drafting plans to make the subprime crisis vanish into thin air. The real trick will be to implement a plan that doesn't cause more harm than good.

Introducing the government-sponsored refinance

Several politicians agree that it might be prudent to allow the government to start buying and refinancing at-risk mortgages. Progressive groups in particular are supportive of the concept. Some conservatives are on board too, while others, including the Bush administration, prefer to encourage lenders and borrowers to work out at-risk loans voluntarily.

Allowing the government to initiate mortgage refinancing is a sensitive area. After all, mortgage lenders and mortgage investors both have a lot to lose. If those two groups of stakeholders are crippled, a mortgage industry recovery will be hampered. Some politicians argue that lender and investor losses can be diffused through a three-step, government refinancing plan:

1. The feds purchase high-risk mortgages from lenders at less than face value.
2. The feds restructure these mortgages, making them more affordable for the borrowers.
3. The feds resell the mortgages in the secondary markets.

Under this plan, lenders and investors would lose expected income, but would recover the majority of their investments. At-risk borrowers would receive an affordable mortgage refinance and avoid foreclosure.

Variants of the plan

Some politicians argue for the creation of a new government agency to implement the plan. Sen. Chris Dodd (D-Conn.), for example, envisions an entity like the Home Owners' Loan Corporation (HOLC) that was established in 1933 to stimulate depression recovery. The HOLC refinanced more than one million at-risk mortgages between 1933 and 1936, and provided debt management and budgeting counseling to its borrowers. Even though almost 20 percent of the HOLC's mortgages ended up in foreclosure anyway, many say the HOLC operation was still highly successful.

Rep. Barney Frank (D-Mass.) doesn't believe that an HOLC-like operation is necessary. He advocates using an existing government agency, the FHA, to run the refinancing program.

The costs

Estimates are that implementing such a plan could cost $10 to $20 billion initially. With proper structuring, however, these costs could be recovered from the refinancing activities. The HOLC, for example, recovered its start-up costs, and returned a modest profit to the government.

Wiping away the subprime crisis isn't like making the Statue of Liberty vanish temporarily. The right assistance plan will have to bring real and lasting changes that accommodate the interests of mortgage borrowers, lenders, and investors.