Jack Guttentag, who I used to call “The Mortgage Curmudgeon,” has some great insights into the origin of the current mortgage meltdown and how to prevent future mortgage crises.
A solution exists and it does not require the dismantling of the existing system. The key is to expand the role of mortgage insurance and extend the reserving principle to the entire system. If this could be done, it would result in a sharp drop in risk premiums paid by borrowers, and a sharp drop in the vulnerability of the system to systemic crises. It could even help get us out of the current mess.
Although this article is from early 2008, I believe he is still behind those ideas.
Here is an article from today from Guttentag about why the FDIC mortgage loan modification plan probably won’t work. (Article may be subscription-only.)
He notes a question that has come up in the comments of this post, “It’s the home prices stupid.
Note: I am told that FDIC avoided balance reductions because they are prohibited on mortgage-backed securities. The last-resort balance reduction described above is only temporary — the borrower has to repay it eventually. While it is true that most pooling and servicing agreements that govern the actions of firms servicing loans in security pools do not explicitly authorize balance reductions, the trustees that represent the interests of investors can authorize them. If necessary, furthermore, government could pass legislation that protects servicers from legal liability if they accept balance reductions that in the best judgment of the servicer are in the interest of investors.
(Emphasis mine.)
So loan mods don’t work unless the loan balance is reduced and the loan balance can’t be reduced (on mortgage-backed securities, anyway).
That is, loan servicers can foreclosure on homes but they can’t forgive any of the loan amounts.
FWIW, I think it’s a very real possibility that by the time the government and/or banks hit upon a good program and then gear up to implement that program, that the housing bust will be long over.