Foreclosure crisis vexes government

WASHINGTON — Each day from July through September, more than 2,700 Americans lost their homes in foreclosure.

That number, up from 1,200 a day a year ago, is a sign that the mortgage industry and government programs have done little to help troubled homeowners.

The mortgage market's troubles have proved to be far more serious and intractable than most in government or the private sector had predicted a year ago.

"We are behind the curve. We are falling behind," Sheila Bair, head of the Federal Deposit Insurance Corp. told a Senate hearing Thursday. "There has been some progress, but it's not been enough, and we need to act. And we need to act quickly, and we need to act dramatically to have more wide-scale, systematic [loan] modifications."

More than 4 million homeowners with a mortgage were at least one month behind on their payments at the end of June, according to the latest data from the Mortgage Bankers Association, and a record 500,000 had entered the foreclosure process.

So why is the foreclosure crisis so hard to fix?

There are five main reasons:

* Crashing home prices:

A massive speculative bubble in housing prices caused millions of Americans to think of their homes as an investment, rather than a place to live.

Now prices are plummeting, especially in once-sizzling markets like California, Florida and Nevada. And the bleeding might not stop until the end of next year.

The median home price in the U.S. dropped 9 percent in September from a year ago to $191,600, the National Association of Realtors said Friday.

Already, 23 percent of home­owners with a mortgage owe more on their loans than their homes are worth, and that figure is expected to rise to 28 percent by this time next year, according to Moody's Economy.com.

While the majority of homeowners will continue to make their payments and wait for values to recover, some will mail their keys to their lender and walk away, leaving the lender with no choice but to foreclose.

* Investor speculation:

Plunging prices have had even more effect on investors than on homeowners because investors have less emotional attachment to a house. They're even more likely to walk away, especially if they've put little money into a property.

Investors purchased one of every five homes last year, and almost one of every three when the market peaked in 2005, according to the Realtors trade group.

They flocked to hot markets like California, Florida, Nevada and Arizona, as television shows such as A&E's popular reality series "Flip This House" touted the easy money that could be made buying and selling homes.

They took advantage of risky loan products that didn't require down payments or proof of income. Other loans allowed the borrower to pay only the interest on the loan, or even less, and none of the principal for a certain time.

Government programs to help homeowners are specifically designed not to help such investors, though in reality it may be hard to weed them out.

* Complex investments:

Traditionally, lenders evaluated borrowers carefully because they held onto the mortgages for the life of the loan. That process started to change in the late 1980s, as Wall Street found new ways to package the loans into securities to sell to investors.

Investors were attracted to these new mortgage-backed securities because they paid better returns than government bonds.

At the beginning of this decade, the Federal Reserve started cutting interest rates to historic lows. So investors poured money into the U.S. mortgage market, particularly into securities made up of high-interest mortgages made to borrowers with poor credit records.

The high-interest, risky mortgages, called "subprime," boomed, from $160 billion in new loans in 2001 to more than $600 billion in both 2005 and 2006, according to Inside Mortgage Finance, a trade publication.

Lenders stopped worrying about the creditworthiness of borrowers and offered them ever-riskier mortgages. Most of those loans were made by commission-driven mortgage brokers, who had nothing to lose if the mortgage went bad because it had been resold.

"By the time it defaults, it's somebody else's headache," said Barry Ritholtz, chief executive officer of research firm FusionIQ.

* Job losses:

The No. 1 reason people fall behind on their mortgage is loss of a job, or some source of income, perhaps from a divorce or death of a spouse. If a borrower is unemployed, lenders don't have many options but foreclosure.

Two years ago, about 36 percent of mortgage delinquencies were caused by loss of income or unemployment, according to research by mortgage finance company Freddie Mac. But that number has risen to 45 percent this year as the unemployment rate has ticked up to a five-year high of 6.1 percent.

* Falling behind again:

It's hard to fix something that keeps breaking. Roughly one-third of all subprime loans modified in the third quarter of last year were delinquent again within 10 months, according to a Credit Suisse report released this month.

Maria Martinez, 57, an administrative worker at the county jail in Stockton, Calif., is typical of homeowners who have gotten help, but not enough. She is three months behind on her mortgage, even after receiving a loan modification earlier this year.

Though Martinez bought the house more than a decade ago for only $76,000, she now owes about $230,000 because she refinanced her home loan several times.

"I was trying to borrow some money to pay some bills," said Martinez, who is on leave from her job this month after being diagnosed with cancer. "I didn't really think ... that I would get into a bind like this."

* So what has and should be done?

The scale of the mortgage crisis became clear in July 2007 when Countrywide Financial, then the nation's largest mortgage lender, reported an unexpected surge in defaults in high-quality mortgages.

Three months later, the Bush administration announced a new mortgage industry coalition — dubbed the Hope Now alliance. The coalition had an "aggressive plan to reach more homeowners and help them find a way to stay in their homes," Treasury Secretary Henry Paulson said at the time.

The Hope Now group says the industry has modified 765,000 loans since last July, and put 1.5 million borrowers on temporary repayment plans. There are no data on how many of those home­owners have fallen behind again.

Faith Schwartz, the coalition's executive director, said the effort was never meant to be the only solution to the foreclosure crisis.

Industry and government responses have also drawn fire from consumer advocates for being too slow and too narrow.

The Federal Housing Administration, a government agency that backs loans to borrowers with weak credit, says it has helped about 400,000 borrowers refinance over the past year, though only about 1 percent were behind on their loans.

This month, the FHA started the "Hope for Homeowners" program, included in legislation passed over the summer by Congress. It is designed to let another 400,000 troubled homeowners swap their mortgages for traditional 30-year fixed rate mortgages, but only if lenders agree to reduce the value of a loan and take a loss.

But there are still questions about how eager lenders will be to participate.

Faced with public outrage that they passed a $700 billion plan to rescue the financial industry, politicians in Washington are going to keep trying to find ways to fix the foreclosure crisis.

One promising approach came this month when 11 states entered into a more than $8 billion settlement with Countrywide Financial and its new parent Bank of America Corp.

The settlement, which goes into effect Dec. 1, is projected to help an estimated 400,000 Countrywide borrowers by allowing them to replace risky loans with ones at substantially lower interest rates.

And in Washington, the FDIC's Bair has proposed a plan in which the government would provide guarantees for mortgages that have been reworked by banks, lowering payments to more affordable levels.

All eyes now are on Bair, Paulson and other top officials to see if the government can craft a plan that gets at the heart of the global financial meltdown — the U.S. foreclosure crisi