TALK BACK:Assumable Loans Would Help Stabilize Housing Market

A reader responds to the following question we posed on Dow Jones NewsPlus: Is the government plan to modify loans enough to boost the housing market? Please share your own views. Email us at TalkBackAmericas@dowjones.com.

It's frustrating to read The Wall Street Journal and watch CNBC every day and see that our country, after more than a year, has still not figured out a way to best deal with the mortgage mess/housing crisis that we are facing.

Yesterday we were offered another seemingly unimaginative plan from the Federal Housing Finance Agency for Fannie- and Freddie-issued mortgages, which will, in my opinion, have minimal impact on halting the descent in home prices and alleviating homeowner financial stress.

There is a better way to stabilize the housing market. We need a plan that will liquefy homeowners who are in poor financial shape, whether it be because they are underwater on their mortgage and/or the weakening economy has otherwise left them in a financial predicament. The plan needs to stabilize the banking system, stabilize the housing market, lubricate the housing market so that the rate of transactions increases significantly and, most important, halt the perceived deterioration in home prices that has created a self-perpetuating credit crisis/real estate bear market.

If you could package all of these into one program, in and of itself it would represent a stimulus package.

Here is a plan that would go a long way toward stabilizing the mess. Effective tomorrow, nationwide, regardless of the previous terms, covenants, conditions or interest rates, every mortgagor in America now has either a 15-year loan at 4 1/4%, a 23-year loan at 4 1/2% or a 30-year loan at 4 7/8%, whichever the borrower chooses to convert to.

I know these types of things have been proposed, but wait - here is the kicker. Every one of these loans has the covenant attached to it that the mortgage is assumable should the homeowner choose to sell his home. Additionally it can be assumed for the life of the loan. However, it can only be assumed once and the buyer must qualify along current Fannie- or Freddie-type guidelines.

An assumable loan is simply a loan that allows a home buyer to take over a seller's mortgage when purchasing a home. A home that is for sale that has a below-market interest rate attached to it has historically added significant value.

By instituting this plan nationwide it would create large and immediate benefits to the economy. Recent home purchasers who are severely underwater relative to their principal balances or those hurting as a result of the weak economy now would have an asset that is likely to sell much faster, liquefying those who need it relatively quickly and also creating closure for the banks that would otherwise be looking at a long workout of foreclosure into a continually declining real estate market.

For those who are fortunate enough to not be underwater on their homes or not feeling the pinch of the stagnating economy, their likely choice would generally be to stay in their homes and reap the benefit of the lower cost of their mortgages but have the peace of mind knowing that should they wish to sell their house in the future any mortgage balance attached could be assumed by a buyer.

Another benefit of this program would be that it discourages the purchases of new homes and targets the large inventories of existing homes for sale nationwide. Since these loan modifications would only pertain to existing mortgages, there would be no incentive for home buyers to purchase newly constructed homes. Not to state the obvious, but we don't need anymore new homes at the current time. So stop building them!

The difficult part, of course, is turning the proposed plan into a workable plan. There are, of course, many different owners of these previously originated and often securitized loans. For all loans held by Fannie and Freddie, the modifications would be relatively simple. For all intents and purposes these entities have been nationalized.

Additionally, relative to FHFA Director James Lockhart's proposal on loan modifications, this is far more equitable. For loans held on the balance sheets of our nation's banks, the modification process should be a relatively unarguable point from the perspective of the banks. Taxpayers through their ownership of the Federal Reserve Bank of the United States are now subsidizing ultra-cheap funds via the Fed window at 1% and until the banks are back on stable ground the Federal Reserve will continue to subsidize this cheap money.

Give us back some of the benefit as taxpayers. Also, as taxpayers, we fund the U.S. Treasury and its massive $700 billion Troubled Asset Relief Program, which has bailed out the banks' losses through capital injections and, imminently, bad asset purchases.

Where loan modifications under the terms described would get tricky is when these previously originated loans have been securitized and placed in private hands (i.e., not Fannie, Freddie, or U.S. banks or thrifts). To the holders of these pooled loans, these mortgages represent contracts that have been negotiated at arm's length between a borrower and a lender, and the government has no place in altering privately negotiated contracts.

However, being that mortgage-backed securities owners would be left holding unsalable securities at this time - with mortgages heavily underwater, not performing and likely subject to short sales - it would seem likely that with current market conditions for resale; the already formed Hope Alliance of mortgage holders and servicers; a Treasury that has no reservations in strong-arming MBS holders; and the boys at TARP, there should be some kind of mutually beneficial approach to generating an exchange value for existing outstanding securities for the newly issued 4 1/4% to 4 7/8% pools of mortgages. These offer far more hope of principal recoupment and, more important, offer the foundation to stabilize the real estate market and the economy.

After all, if the team at TARP thinks they can establish a liquid market for thousands of currently illiquid heterogeneous securities, allowing for accurate price discovery, then the act of simply negotiating a value for a specific security for purposes of determining an exchange value should be child's play. It would also be far less costly to the government simply by virtue of its ability to put a floor under the housing market and the economy.

The plan, my plan, is really quite simple. By issuing to all mortgagors a one-time below-market mortgage rate paired with an assumption covenant dividend, there is value injected into the housing sector that would go a long way toward putting in a floor for residential real estate prices, lubricating the housing market so that homes begin selling again, liquefying hurting homeowners, rewarding disciplined borrowers who didn't overstep their ability to repay, liquefying bank balance sheets and adding a major building block toward stabilizing the U.S. economy. It's certainly the closest thing I have seen to an equitable approach.

(TALK BACK comments may well be submitted by readers who have a financial interest in the securities that are being discussed.)

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