SPEA brief sees no obvious answer for underwater mortgages

The IU School of Public and Environmental Affairs released a new policy brief Tuesday that finds no obvious answers for the millions of American homeowners who are “underwater” on their mortgages, owing more than their property is worth.  

IU assistant professor Ashlyn Aiko Nelson noted in a May 2010 issue of SPEA Insights that the federal response, focusing on stabilizing the financial sector and encouraging the modification of some problem mortgages, has done little to curb the rise in mortgage defaults and foreclosures.

“There is a growing realization among federal policymakers, mortgage lenders, and servicers, as well as underwater borrowers themselves, that existing loan modification programs are insufficient and only more drastic measures will stem the surge in mortgage defaults,” Nelson writes. “Yet questions remain about how best to solve the problem, and whether taxpayers will be able to stomach the cost of additional loan modification programs.”

The policy brief is part of a monthly series produced by SPEA faculty members, with each member writing a segment about his or her area of research and expertise.

According to an IU press release, in Nelson’s brief she “explains that the underwater mortgage crisis developed from a rapid expansion of home ownership opportunities, followed by sharp declines in housing prices that had reached a peak in mid-2006. By the end of 2009, American households had lost $7 trillion in real estate wealth, 13.6 percent of U.S. mortgages were delinquent and more than 5 million households were at risk of foreclosure.”

“The federal government now has the unenviable task of designing policies to keep underwater mortgages from undermining economic recovery,” Nelson writes.

According to the press release, the Obama Administration has responded to the current situation with the $275 billion Home Affordable Modification Program, which offers incentives for lenders to modify mortgages. However, the program has helped only a small percentage of delinquent borrowers.

Some experts have argued that a more effective solution would be to forgive loan principals instead of modifying mortgage terms. Recently, Bank of America and the U.S. Treasury Department followed this proposed solution by forgiving or writing down the principal on some underwater mortgages.

“Whether these new programs are effective -- or induce moral hazard by creating additional incentives for borrowers to default, as some critics warn -- remains to be seen,” Nelson writes.
    
— Bailey Loosemore