New FDIC Plan Will Help Clients of The Loan Modification Center

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Sheila Bair, chairperson of the Federal Deposit Insurance Corporation (FDIC), believes that mortgage renegotiations are the best way to resolve the current housing crisis. However, critics have raised doubts about the viability of this proposed approach.

Sheila Bair, who was named chairperson of the Federal Deposit Insurance Corporation (FDIC) in 2006, has reiterated her view that the best approach to resolving the current housing crisis is to encourage lenders to renegotiate mortgages with homeowners.

Bair's proposal calls for a loan modification program so that payments are reduced to 31% of homeowners' gross income (Sasseen & Francis, 2008). The federal government would guarantee to cover part of the losses if the homeowners re-default despite this assistance. Bair claims that this approach would save 1.5 million homeowners and would cost the federal government approximately $24.4 billion (Sasseen & Francis, 2008).

The proposed approach has faced a barrage of criticisms and doubts. Some have claimed that the renegotiation of millions of mortgage loans will take too long to have a practical effect (Wallison & Pinto, 2008). Others have pointed out that it will be difficult to renegotiate certain types of loans, particularly those that have been securitized, or sold to investors (Sasseen & Francis, 2008). Critics have also argued that previous efforts to renegotiate mortgages have not been particularly successful. Specifically, there is evidence that more than half of the mortgages renegotiated during 2008 are already at least 30 days past due (Sasseen & Francis, 2008). Treasury Secretary Hank Paulson argues that Bair's plan is problematic because it increases government expenditures and it rewards banks when homeowners default (Sasseen & Francis, 2008).

Alternative solutions have been proposed for the housing mess, but these too have perceived flaws. For example, bailing out the major mortgage companies might simply encourage further risky practices in the future (Murphy, 2008). Treasury Secretary Paulson claims that the best approach is to reduce mortgage rates, in order to encourage more home purchases. However, this approach has been criticized because it won't help borrowers who are already in trouble (Sasseen & Francis, 2008). Martin Feldstein, a Harvard economist, has suggested that the federal government should make loans to troubled homeowners to cover 20% of their mortgages (Feldstein, 2008). However, this raises the risk of borrowers, in turn, defaulting on their debts to the government (Murphy, 2008). There is, additionally, widespread sentiment that helping companies or borrowers who got themselves into trouble is unfair to those who made more reasonable financial decisions.

The housing crisis came about because trillions of dollars of mortgage loans were made to borrowers who were not really able to repay the loans. Many of the loans were based on adjustable rates that greatly increased the size of homeowner payments after a certain period of time (Murphy, 2008). The situation led to a growing number of defaults and a substantial decline in housing values. The proposed solutions to the problem are based on the question of whether it is better to assist mortgage companies or borrowers. There seems to be a partisan divide on this issue, since many Democrat politicians, such as Bair, are in favor of helping borrowers, while Republican leaders, like Paulson, are in favor of helping the big companies. In spite of this controversy, there is widespread agreement among policymakers that the most important step is to strengthen regulation of the housing market and the mortgage industry (Murphy, 2008).

Feldstein, M. (2008). How to help people whose home values are underwater. Wall Street Journal (November 18), A21.

Murphy, R. P. (2008). Can the Feds save the housing market? Freeman 58(5), 8.

Sasseen, J., & Francis, T. (2008). A standoff over housing relief. Business Week (December 22), 30.

Wallison, P. J., & Pinto, E. (2008). Let's use Fannie to clean up the mess it made. Wall Street Journal (October 25), A13.

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