Bailout: Little help for homeowners

NEW YORK (CNNMoney.com) -- The $700 billion bailout legislation now under consideration by Congress calls for the Treasury Secretary to implement a plan to stem foreclosures by working with servicers to modify loans.

But many housing experts question whether the bill will help struggling homeowners refinance into more affordable mortgages. They stress that the economy won't recover until the tide of foreclosures stops, and the million-plus foreclosed homes on the market find buyers.

"It's impossible to know whether it will help anybody but the banks stay open another week," said Mark Dotzour, chief economist at the Real Estate Center at Texas A&M University. "Until we see a plan to get people to buy those empty homes, we're just going to go from one band-aid to the next."

The legislation was unveiled Sunday, but voted down by the House on Monday. It's now up to lawmakers to revise the bill so it can garner approval from enough members to pass. The main objections were levied by House Republicans and are centered around the potential risk to taxpayers.

Since the credit crisis began a year ago, Democratic lawmakers and the Bush administration have tussled over how much to help borrowers who have fallen behind in their mortgage payments. Until now, efforts have focused on prodding lenders to work with distressed borrowers.

In Sunday's version of the bill, federal agencies holding mortgages and mortgage securities would be required to identify loans that could be modified without causing big losses for taxpayers. It calls for encouraging servicers to refinance loans through the Hope for Homeownership program, which begins Oct. 1 and allows borrowers who can't meet their current mortgage terms to refinance into more affordable, fixed-rate loans backed by the Federal Housing Administration.

However, exactly how the modifications would be done isn't totally clear.

Generally, when considering whether to modify a loan, servicers determine whether the borrower has the means to make payments on their loan, if the loan terms were changed slightly. At the same time, the servicer considers whether it would cost less for it to modify the loan instead of foreclose.

Often when a borrower is up-to-date on payments, but faces a big spike in rates, the modification may call for freezing interest rates at the introductory level. The workout could also reduce principal balance or stretch out the term of the loan, from 30 years to 40 years, for example.

In addition to the Treasury Department, agencies that would promote the modifications would include the Federal Reserve, Federal Deposit Insurance Corp., and the Federal Housing Finance Agency, which controls mortgage insurers Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500).

The bill also allows the Secretary to use loan guarantees and credit enhancements to avoid foreclosures, though on a press call Treasury officials declined to elaborate on these provisions. Loan guarantees generally refer to mortgages backed by a federal agency, such as the Federal Housing Administration, or by mortgage insurers Fannie Mae and Freddie Mac. Credit enhancements usually reduce the risk of mortgage securities or loans in case borrowers default.

Servicers have been under pressure to modify loans since the mortgage meltdown began a year ago. However, they say the biggest roadblock to changing loan terms are the investors who hold the securities created from those mortgages.

"It's really not the servicers' decision," said John Harding, real estate finance professor at the University of Connecticut School of Business.

But, as the owner of a large number of mortgage securities, the federal government would have the power to modify more troubled loans, said Treasury officials. The government may also buy the mortgage loans themselves from banks, which it can then adjust more easily.

The government would try to avoid "preventable foreclosures" in a way that "makes sense for taxpayers," the officials said on a press call.

"We will have a lot of influence," they added.

But just how far the government will go to help homeowners remains in doubt. Treasury Secretary Henry Paulson said last week that the "vast majority" of foreclosures in this country are happening to people who took out loans they couldn't afford or who don't want to stay in their homes.

Some housing counselors said the legislation falls far short of helping troubled homeowners. One of the best ways to stop foreclosures would be to allow bankruptcy judges to change the terms of some mortgages to make them more affordable, a measure the banking industry strenuously opposed.

"There is nothing in the bailout that will mitigate widespread damage caused by foreclosures," said Michael Calhoun, president of the Center for Responsible Lending.

"The bill includes a vague provision that calls for the government to buy mortgages and securities and then try to modify them, but this will have very limited impact," he continued. "It doesn't stop the [foreclosure] epidemic that will continue to drag down property values for everyone."

The bill's failure in Congress pleased some community activists, who saw it as an opportunity to renegotiate the housing provisions in the bill. In addition to including the bankruptcy provision, housing groups would like to see stronger language in the legislation to help homeowners, said Bill Austin, director of Acorn Financial Justice Center. For instance, the Treasury Department could put a higher priority on buying securities that have underlying mortgages that need to be modified.

Still, even if some homeowners are helped, it's not going to quickly put the American economy back on its feet, said Shaun Bond, associate professor of real estate at University of Cincinnati's business school.

"The adjustment in the housing market will still be a long, drawn-out process," Bond said. "It will be several years before we see a return to normal conditions."