Plans for a massive expansion of FHA loan guarantee programs got a boost this week when Senate Republicans agreed to include the idea in a compromise bill if Democrats would drop a controversial proposal to allow bankruptcy courts to "cram down" the mortgage debt of troubled borrowers.

Tuesday’s agreement between Majority Leader Harry Reid, D-Nev., and Minority Leader Mitch McConnell, R-Ky., could lead to a congressional debate over a $300 billion to $400 billion expansion of Federal Housing Administration loan guarantee programs

Plans for a massive expansion of FHA loan guarantee programs got a boost this week when Senate Republicans agreed to include the idea in a compromise bill if Democrats would drop a controversial proposal to allow bankruptcy courts to "cram down" the mortgage debt of troubled borrowers.

Tuesday’s agreement between Majority Leader Harry Reid, D-Nev., and Minority Leader Mitch McConnell, R-Ky., could lead to a congressional debate over a $300 billion to $400 billion expansion of Federal Housing Administration loan guarantee programs

In the House, Rep. Barney Frank, D-Mass., has proposed authorizing the FHA to help refinance up to 2 million loans in cases where lenders agree to substantial principal write-downs. Sen. Chris Dodd, D-Conn., has put forward a similar plan that could be included in a bipartisan compromise bill expected to be introduced in the Senate today.

The Federal Reserve has made billions in loans available to lenders and investment banks that put up mortgage-backed securities as collateral. But critics of the Bush administration maintain the federal government must buy up troubled loans directly in order to stem a rising tide of foreclosures.

Frank’s plan would limit lenders to recovering no more than 85 percent of the property’s current value as payment for an existing loan. To prevent borrowers from profiting from the write-downs, the FHA would hold a soft second lien, limiting or eliminating their profits when they sell their home or refinance (see Inman News story).

Advocates of such an approach, including the National Community Reinvestment Coalition, say such measures are needed to reduce pressure on inventories and end a vicious circle of housing price declines and foreclosures.

Although Federal Reserve Chairman Ben Bernanke has urged lenders to make voluntary write-downs of loan principal in cases where it would allow borrowers to stay current on their loans, the Bush administration has rejected calls for the government to buy up troubled loans, calling such a move a bailout of speculators. The administration and other opponents have said that such efforts would artificially prop up housing prices and prolong the housing downturn.

The Bush administration has made FHA loan guarantee programs part of its foreclosure prevention efforts, however, creating the FHASecure program to help borrowers with adjustable-rate mortgage (ARM) loans refinance into 30-year, fixed-rate loans.

Critics say many borrowers don’t qualify for that program, and won’t be helped by the voluntary interest-rate freezes lenders are offering to some borrowers. In markets where prices are falling and some borrowers now owe more than their homes are worth, some experts say the only thing that will keep some borrowers from walking away from their homes are reductions in loan principal.

To encourage lenders to make voluntary reductions in loan principal for borrowers in declining markets, some Democrats supported changing the bankruptcy code to allow judges to modify the terms of mortgages on principal residences.

The Bush administration has said it would veto any such legislation, and Republicans have been able to prevent a floor debate of a bill that would have allowed "cramdowns," The Foreclosure Prevention Act of 2008, S 2636 (see story).

After Reid agreed to drop the cramdown proposal, the Senate in a procedural vote Tuesday voted 94-1 for Dodd and his Senate Banking Committee co-chairman, Sen. Richard Shelby, R-Ala., to draft a compromise foreclosure relief bill.

In addition to allowing FHA to buy up troubled loans, the bill is expected to include other provisions originally put forward in S 2636, including $200 million for preforeclosure counseling, and an authorization for state housing finance authorities to issue $10 billion in mortgage revenue bonds to refinance subprime loans and provide mortgages for first-time home buyers.

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