Bailouts Worsen Foreclosure Crisis, Economist Says

Bailing out home foreclosures will only worsen the crisis it is trying to solve, according to Federal Reserve Bank of Boston economist Paul Willen. He said that bailouts will lead to more delinquencies and write-offs and will be more costly to both mortgage banks and taxpayers.

Willen co-wrote a study proving that U.S. foreclosures in 2007 and 2008 are following a historical foreclosure pattern and not causing a catastrophic avalanche of foreclosures.

He explained that offering bailouts will encourage homeowners who have been paying their amortizations on time to default and go into foreclosure in order to take advantage of cheaper payments. He said that taxpayers' money would be spent on scores of homeowners who do not really need help.

Willen's proposal is to allow the housing market to find its level without artificial supports and to ultimately find the level where houses become affordable to many, encouraging homebuyers and investors to return and thereby stimulate the housing market naturally.

Two of the leading foreclosure prevention schemes analyzed by Willen are the HOPE for Homeowners Program (H4H), run by the Federal Housing Administration (FHA), and the loan modification program run by the Federal Deposit Insurance Corporation (FDIC). Both of the programs are optional; the mortgage banks are not mandated to offer them to their borrowers.

Under the H4H, the mortgage bank takes a loss to reduce a homeowners' loan balance and then transfers the new loan to the FHA. Under the FDIC plan, the bank lowers the interest rate to reduce monthly payments. The FDIC guarantees up to 50 percent of the bad loan if the borrower again defaults.

It is to be noted that both bailout plans have adverse consequences to all parties, namely the government, the taxpayers, the banks and the borrowers themselves. How? The plans would attract scores of homeowners who would use the plans not to avoid foreclosure, but to reduce to a large extent the total cost of their homes.