The great worry is that, rather than stabilizing, the housing market will spiral downward. Homeowners default in greater numbers when their loan balances exceed the value of their homes. That, in turn, results in more foreclosures and downward pressure on prices.
This explains the pressure on the government-linked enterprises to steady the market.
The House of Representatives appeared poised to vote Wednesday on a bill designed to stem a record tide of foreclosures.
Among other things, the bill would call for the Federal Housing Administration, a government agency, to let cash-strapped homeowners refinance into more affordable, fixed-rate mortgages. Before the FHA agreed to refinance the loans, the current lenders would have to agree to take substantial losses. That means the federal agency would insure a loan that’s smaller than the original one, for about 85 percent of the current value of the home.
The approach might help half a million borrowers keep their homes, according to the Congressional Budget Office. That would help at a time when foreclosures are running at a pace of more than a million a year.
But it would leave the government vulnerable if a high number of borrowers later default on their new, FHA-insured loans. Traditionally, FHA borrowers pay premiums that cover this default risk. Taxpayers might be on the hook in a scenario of high defaults and collateral (property) that falls another 15 percent or more in value after the refinancing.
Fannie and its sibling, Freddie Mac, don’t carry official backstopping by US taxpayers. But they are widely seen as institutions too large and important to be allowed to fail if they ever faced bankruptcy.