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Treasury Secretary Timothy Geithner said he would look into launching pilot programs for a new idea to help more than 8 million underwater borrowers refinance.
Sen. Jeff Merkley, D-Ore., introduced a plan this week for the government to buy underwater mortgages from banks, reduce the principal for eligible borrowers and refinance the loan into a new Federal Housing Administration-backed mortgage.
The FHA, the Federal Home Loan Banks system or the Federal Reserve would set up a trust and buy the home loans with revenue from government bonds. Merkley said the Rebuilding American Homeownership Trust would profit on the difference between the interest rate of the new loan and the borrowing costs on the bonds.
"We like the way you designed it," Geithner told Merkley at a Senate Banking Committee hearing Thursday. "It would help reduce the remaining pressures that housing has on the economy. It doesn't leave the taxpayer to pay for it."
Merkley's plan allows use of leftover housing program funds from the Troubled Asset Relief Program instead of selling more government debt. Just 10% of the more than $45 billion set aside for foreclosure prevention has been spent, according to the Special Inspector General for the Troubled Asset Relief Program.
Some are more skeptical of the Merkley plan. Partick Pulatie of LFI Analytics said generally borrowers below the 140% loan-to-value ratio line prefer to stay in their home rather than walk away.
"As Fed studies show, loan-to-value for underwater borrowers is not a factor in defaults, unless there are income pressures. At that time, LTV may play a part in default decisions," Pulatie said. "People who have the money to make payments, continue to do so, even if underwater."
He pointed out another problem in Merkley's plan, regarding an option for a borrower to split the new refinanced loan into a first mortgage equal to 95% of the home's value and a "soft second," covering the part in negative equity but would be uncollateralized. Borrowers would not be required to pay on the "soft second" for five years.
Pulatie said since the second is unsecured a bankruptcy would wipe it out if the borrower chooses that route after refinancing.
Still, Geithner said the question would be whether Treasury has the legal authority to launch such pilots to test the plan.
In his paper, Merkley said one or more states could lead the way. Florida, for example, has $900 million in unspent Hardest Hit Fund money, which could be used to refinance 6,000 mortgages through the trust.
Merkley even said states could use some of the money from the mortgage servicing settlement struck in March between the five largest banks and the state attorneys general.
Current law prohibits building new programs with money allocated to the Home Affordable Modification Program or other refinance projects, but Merkley said the RAH program is similar enough to be funded with this money.
"I think the policy is very good," Geithner said. "We would like to work with you on it. The question is do we have legal authority and resources on it to launch pilots?"
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