In 1972, the U.S. Department of Housing and Urban Development (HUD) created a working task force charged with dismantling HUD’s failed New Communities Program. This program dated from the late 1960s, when Congress authorized HUD to guarantee the debt developers had assumed to build "new communities" based on the Reston, Virginia, and Columbia, Maryland, models.
The program was used largely by undercapitalized developers in slow-growth communities such as Rochester, New York, and Dayton, Ohio, and in rural North Carolina. But when these new communities failed, HUD was left not only liable for its guarantees, but also facing creditors who, relying on HUD’s commitment, had advanced credit or sold land subject to seller-financed mortgages.
The task force had to obtain title to the properties from the original developers, settle debts with well-intentioned creditors, and then resell the land to new investors. Although these buyouts entailed major losses, the task force used the concept of "HOPE certificates" to ensure that over the long term, if the new developer earned a windfall, the proceeds would be shared with HUD.
In 2008–2009, the U.S. Treasury Department used a similar strategy when it bailed out General Motors, Chrysler, and AIG, taking back the equivalent of HOPE certificates in the form of stock—which is now returning most of, if not all, the money advanced by the Treasury.
Today, the federal government faces comparable challenges involving the potential writedown of home mortgages.
To help stabilize the housing market, the Obama administration has been urging that borrowers be allowed to reduce the principal on loans owned by Fannie Mae and Freddie Mac. But the Federal Housing Finance Agency, conservator for these government-sponsored enterprises (GSEs), worries that this proposal will cost the federal government significant sums and, moreover, encourage other homeowners to default on their mortgages so they, too, can obtain relief. (Treasury’s recent offer to pay about two-thirds of the forgiven debt reduces the potential losses to the GSEs, but not to the taxpayers.) The conservator is also concerned that if first mortgages held by the GSEs are reduced, all second mortgagees will be unjustifiably enriched because the reduction increases the likelihood that they will be repaid.
On August 1, the conservator decided that Fannie Mae and Freddie Mac should not write down the principal on loans they control because such a decision would lead other homeowners who are current on mortgage payments to default.
The concerns of the conservator are valid, but there is a constructive way to deal with them: the GSEs could require homeowners who receive principal relief to transfer the land underlying their units to Fannie Mae or Freddie Mac, which would hold the land for itself and for any second mortgagee. The GSE would thereby establish the value of the principal being deferred by itself and by any second mortgagee. In return, it would receive an asset against such deferment, which would bear an interest rate of 1 percent. The GSEs would also oblige homeowners to use 60 percent of sales or refinancing proceeds, above the reduced amount of their mortgage, to pay off their land leases. Even after a home was sold, the lease would remain in effect until it was eventually paid in full. Where there is a second mortgage, the lender would have to agree to this transfer—an outcome surely preferable to foreclosure. The GSEs could also use this land-lease concept to remarket foreclosed properties.
To enhance the appeal of owning a house that is subject to a land lease, purchasers could be accorded 20 percent of the appreciation as a discount. Alternatively, the GSEs could allow outstanding mortgages to be assumed by new buyers at an interest rate 50 basis points below the current market rate.
How would this work in practice? Let’s take a property purchased several years ago for $250,000 with a first mortgage of $225,000, reduced to $220,000 through payments of principal, and valued currently at $175,000. Under these conditions, the mortgage would be written down to $175,000. The GSEs would purchase the land underneath the unit for $1, and lease the land to the current mortgagor for 99 years. The mortgagor would be required to reimburse 60 percent of any sale or refinance proceeds above the written-down mortgage to the land lessor, until the $45,000 in loan forgiveness had been repaid. If the home appreciated by 4 percent per year over ten years and was then sold, title to the land would revert to the then-current mortgagor, and the GSE would recoup its full investment. If a second mortgage were in place, it would be reduced on a pari passu basis (treated equally with the first mortgage) to reach the $175,000 figure; the second mortgagee would then receive its allocable share of the ground-lease proceeds.
This approach overcomes three hurdles to resolving the housing crisis:
Compared to current policy, it costs the government less. At present, to bring a mortgage down to market value, both GSEs already offer to forebear (put in abeyance) a portion of the principal. One hundred percent of any appreciation, up to the amount of the forbearance, must be repaid to the GSEs at the time of sale or refinance. However, the arrangement does not apply to subsequent buyers. Therefore, if the original owner sells a home within one or two years with limited or no appreciation, the GSEs lose most of their subsidy.
It delivers the much-touted psychological benefits of a mortgage writedown. Investigators claim that a reduced loan-to-value ratio will convince homeowners to keep up their mortgage payments rather than returning the keys to the lender.
By requiring borrowers to return to the government some or all of what has been forgiven, it avoids angering the many other borrowers who are also underwater but who have remained current on their mortgage payments.
The United States will add more than 26 million households in the next 20 years. Because many of these families will want to buy a home, the price of housing will begin to rise once more and, in many geographical areas, will exceed what was considered excessive in 2007–2008. All that is needed is patience—a commodity the GSEs are well positioned to extend. UL
Myron P. Curzan is the chief executive officer of Maryland-based UniDev, which specializes in developing housing for moderate-income public employees. He was a legislative assistant for Sen. Robert F. Kennedy and sat on the New Communities Task Force. Janet Lowenthal has worked as a writer for legal and environmental nonprofit groups.