Everybody is charting job growth and foreclosures. While many analysts say job creation is the primary driver of home sales, the hole that’s been dug by bad loans is too deep to be offset by a modest rise in future employment.

The reality is more foreclosures than ever are scheduled for 2010. What can be done about it?

A decade of cheap money and incredibly flexible loan programs offered by many lenders sparked overbuilding by developers, a flip-and-run mindset for speculators and unrealistic expectations for first-time homebuyers blinded by the low payments of a short-term loan.

According to Edward Pinto, a consultant to the mortgage-finance industry and former chief credit officer at Fannie Mae, the over-stimulus provided by Fannie, Freddie, the Federal Housing Administration and the Community Reinvestment Act created the housing boom that went bust.

The response to the bust has been to provide yet more stimuli that are serving to delay the market-clearing process. The "market-clearing process" means allowing the traditional housing forces to return to the scene.

Just what are traditional housing forces? In a nutshell, it means skin in the game: make certain that those who can truly qualify to buy a home are also able to produce a downpayment and an income that will allow the repayment of the mortgage, taxes, insurance and monthly essentials.

"All we are doing is kicking the can down the street," Pinto said. "The loan modification programs that were designed to help people stay in their homes have been abject failures. The recent Treasury action lifting the capital support caps did not help. It cleared the decks to use Fannie and Freddie as an open vessel for whatever the administration wants."

What does all this mean? Basically, Pinto believes that the extra cash the government is tossing into the housing market is simply adding fuel to the fire by depressing prices while foreclosures continue to flood the market.

Pinto and others would halt all housing stimulus funds and take some basic steps to curtail foreclosures. The initial steps would be painful, but they believe they are critical to restore balance:

1. Separate those borrowers who are going to qualify at a lesser mortgage amount from those borrowers who will not qualify even at a lesser amount. For those who cannot qualify, lenders assist with rental subsidies for a specific time period in exchange for leaving the home in good condition.

Lenders also accept deeds-in-lieu of foreclosure whereby the borrower deeds the property back to the lender and avoids the foreclosure process.

2. Banks then chop down the loan amount and reduce the mortgage principal amount to at least 90 percent of loan-to-value. Affordable rates and terms are negotiated.

3. If the borrower accepts the reduced amount, he or she becomes personally responsible for the mortgage. The bank would have a "full recourse" loan, enabling it to seek the borrowers’ other assets in the event of default. …CONTINUED

As of now, most foreclosures are nonjudicial, meaning the borrower risks nothing but the equity in the house in the event of foreclosure.

4. The result: Qualified borrowers remain in homes, homes cost less, and more genuine buyers surface because the "bottom" has been reached.

The lending craziness of the 1990s and 2000s was not present in any other decade. Sixty years ago, the average home price in the U.S. was approximately $5,000 and the average debt against it was about $2,500.

In the early 1950s, the prevailing loan-to-value (LTV) ratio was 58 percent, while many of the loans made between 2004-06 had an LTV of 97-100 percent. Some lenders, blinded by the 10-year run-up in home appreciation, were making 125 percent loans.

The government "chartered" Fannie Mae in 1968 and Freddie Mac in 1970 as government-sponsored enterprises (GSEs) so that banks could have more access to mortgage funds.

The two companies for years tried to keep their distance from the U.S. Department of Housing and Urban Development because the agency had been undergoing a variety of internal and housing problems. Their lending decisions were made on financial data, not on political pressure.

In 1975, there were no adjustable-rate mortgages, 80-20 combo loans or equity lines of credit. The minimum downpayment was 20 percent, unless a homebuyer wanted to pay for mortgage insurance, which protects the lender if the borrower defaults. The only way a borrower could get a 3 percent downpayment loan was through FHA. As a result, foreclosure rates were low.

The housing road of the 1980s had its peaks and valleys, but it really took off in 1992-93 when homeownership became more of a priority and the government pushed for creative methods to get people into homes.

The challenge is that housing is systemic. What helps you on the way up pounds you on the way down. Inexpensive loans created demand and inflated prices. When rates adjusted, borrowers could not pay higher monthly obligations and the number of homes on the market (supply) soared.

It’s time to let the market correct itself. That means skin in the game for buyers.

Next week: A lender agrees to take a "haircut" on a senior’s loan.

Tom Kelly’s book "Cashing In on a Second Home in Mexico: How to Buy, Rent and Profit from Property South of the Border" was written with Mitch Creekmore, senior vice president of Houston-based Stewart International. The book is available in retail stores, on Amazon.com and on tomkelly.com.


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