Bailout Blues

The federal government has created a template for widespread loan modifications with the FDIC's bold gambit to rescue thousands of IndyMac borrowers from potentially toxic option-ARM loans. The gist is this: refinance them into a fixed-rate loan at the prevailing Freddie Mac rate so long as the resulting payments do not exceed 38% of the homeowner's income. If the principal, interest, taxes and insurance monthly bill still exceeds 38%, the interest rate may be reduced or other terms adjusted to meet that 38% threshold. In some cases, the FDIC may even consider reducing the principal amount of the mortgage.

The $700 billion financial rescue package (or bailout, depending upon what nomenclature you prefer) recently enacted by Congress also paves the way for more streamlined modifications. With the new law, the FDIC's growing role in the management of troubled banks, and the takeover of Fannie Mae and Freddie Mac, it's clear that the federal government is poised to play a major role in determining how servicers, and investors, respond to the burgeoning number of homeowners who are likely to default on their home loan because they are underwater on their mortgage or because they face escalating payments due to resets on an adjustable-rate or hybrid mortgage.

Is it enough? That's the question that is dogging the financial system, and indeed the entire economy, in today's market. Researchers at Moody's Economy.com estimate that the dramatic drop in home values across much of the country has left one in six homeowners (roughly 16%) owing more on the home that the home is currently worth. That's roughly 12 million households. With an average national home price of $195,000, that suggests home loans backed by $2.34 trillion of real estate are underwater. Of course, that rough calculation doesn't take into account that in many cases, the markets with the steepest price declines have been "high cost" markets with pricey homes, suggesting that the amount of mortgage debt could be quite a bit larger.

As recently as 2007, when the housing crisis was already taking hold, only 6% of homeowners were underwater.

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