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How not to rescue home loans

Let bankruptcy judges and bureaucrats set mortgage rates? Congress needs to think twice.

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New fire engines are being built by Congress to douse infernos in the housing markets. These rescue vehicles, coming eight months before an election, are likely to be popular. In effect, though, they may hurt more than they help.

The various proposals could end up rewarding unwise buyers and investors, tap taxpayers' money, and harm growth in home ownership.

One proposal would ease US bankruptcy rules to allow judges to reduce interest rates and lower mortgage payments for those in financial ruin and facing foreclosure. The concept seems humane for the estimated 1.8 million borrowers who may not be able to cope with adjustable-rate mortgages soon to be reset to higher rates. But it will hurt millions more applying for home loans.

Here's why: Judges would be expected to guess a home's current value and "cram down" the mortgage to that level. To cover the risk of that uncertain intervention by courts on old mortgages, banks would need to raise interest rates on new ones. And such risk would slow the pooling of home loans for resale into securities – a practice that still helps to lower interest rates.

A better route is the Treasury Department's new Project Lifeline. This voluntary plan, agreed to by six major lenders, would grant an added 30-day grace period for homeowners in foreclosure proceedings, allowing more time to work out refinancing. The plan comes after an earlier volunteer one negotiated by Treasury in which major lenders agreed to freeze interest rates on troubled subprime loans for five years. Such collective and private responses help build on a mortgage lender's interest in avoiding costly foreclosures.

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