New Strategy Can Prevent Foreclosures

Mara A. Cohen and Richard Alarcon.  September 14, 2009.  LA Daily News.  Original link:

FRANCISCO and Maria Sanchez figured they had achieved the American dream when they bought their home. But the family budget unraveled under mounting medical bills for Maria's elderly mother and cutbacks at work. That's when their monthly house payments shot to almost $5,000.

The couple now owe far more on their mortgage than their modest Pacoima house is worth.

The foreclosure free-fall will swallow another seven million homes by the end of 2010. Southern California's home values have plummeted 47 percent since their peak two years ago, wiping out billions in equity and prolonging the recession.

More than 100,000 single-family homes, condos and apartment buildings across Los Angeles County are in some stage of foreclosure - either in default, pending trustee sale or bank-owned. That's far more than the 60,000 homes destroyed by the 1994 Northridge Earthquake.

The federal initiative to stem the crisis is a finger in the dike. Five months after the Obama administration put up $75 billion to entice lenders to re-write loans for troubled borrowers, banks and mortgage firms have modified only 235,000 loans. That's out of 3.5 million foreclosures likely this year. Instead of reducing what borrowers owe, most modifications temporarily reduce monthly payments.

With nearly a third of U.S. home loans "underwater," even borrowers with modified loans will soon be back in the same leaky boat, inflated assets will remain on bank ledgers, and

taxpayers - who now guarantee those assets - will be told to grab a bucket and start bailing.

Revising loan contracts costs banks considerable time and effort, and they are legally obligated to secure approval from investors.

Without a compelling incentive to reduce balances on bad loans, the government's strategy can't hold water. Lenders need solid evidence that they can recover more by lowering borrowers' unpaid balances than the pennies on the dollar they get selling repossessed homes. That evidence could come with a bold experiment launched this month in Los Angeles under a pilot program developed by One LA-IAF, a local community group, and Los Angeles City Councilman Richard Alarcon.

Here's how it works: Starting with a small group of delinquent borrowers in the San Fernando Valley, banks will write down loan balances.

Free of gimmicks that contributed to the mortgage market meltdown, the new loans will be the plain vanilla variety with monthly payments pegged to the borrower's ability to repay. The plan uses the Obama administration's guidelines and housing experts' rule-of-thumb standard for an affordable payment - no more than 31 percent of the borrowers' gross income.

In some cases, home values or the borrower's financial condition have deteriorated so far that reducing principal and cutting interest rates won't suffice to achieve an affordable monthly payment. In those situations, city government will plunk down cash on the table for banks to trade in their clunker loans, trimming loan balances even further.

In the case of the Sanchezes, their bank would be asked to shave $40,000 to $60,000 off the couple's loan balance. To achieve an affordable payment, the city will loan the Sanchezes $20,000 to $40,000, paying the sum upfront to the bank. The couple won't have to make payments on this second loan until they sell their home. When they do, the city will share a portion of the appreciation.

Putting the Sanchezes on a path to building equity slashes their risk of defaulting on their new loan, promising banks and investors a better return than the modifications extended so far under the Obama administration's program - and a vastly better return than a foreclosure sale.

The total city government will kick in for a single loan depends on how far the bank reduces the balance and on current market conditions. Because of that cap, the plan won't help every distressed borrower. Still, the strategy would put nearly half of all shaky borrowers in the test site on firm ground.

A playground for predatory lenders who steered borrowers into high-cost loans, one in nine homes in the Pacoima demonstration area are now in default. Home values there have plunged by half. If Los Angeles' foreclosure prevention strategy works in Pacoima, it can work almost anywhere.

Richard Alarcón is a member of the Los Angeles City Council serving the City's Seventh District. Mara A. Cohen-Marks, Ph.D. is a board member of One LA-IAF and senior fellow at Loyola Marymount University's Leavey Center for the Study of Los Angeles.