A federal (and state) lifeline is essential for debt-strapped homeowners

By: Linda Stamato

The subprime loan mess, the financial debacle that has led to foreclosures, defaults, lawsuits and investigations of the mortgage industry by state and federal regulators, is being made worse as the economy slows, credit markets tighten and the real estate market fails to revive. More than 1.6 million mortgage holders missed payments in 2007, and more are expected to default this year, perhaps as many as two million by 2009. Projections, in some quarters, have as much as $700 billion in mortgages at “moderate to high risk” of defaulting.

Regardless of whether one supports bailouts for people who borrowed more than they could afford (or for banks that made questionable loans during the height of the speculation in housing–and, clearly, there are compelling arguments against rescuing banks and Wall Street firms that earned huge fees packaging trillions of dollars in risky mortgages), it seems clear that some kind of intervention is needed in order to avoid major disruptions in the nation’s economy. Prospects for a federal mortgage guarantee for troubled borrowers, using government funds to purchase and refinance billions of dollars in mortgages now in danger of default, is under serious consideration in Washington.

Meanwhile, Project Lifeline, the federal government’s effort at the micro level, would give homeowners more than three months behind on their mortgage payments a one month grace period to work out plans to avoid foreclosure, thus putting a stop on proceedings so that homeowners can attempt to negotiate new terms. This program has the potential to help both homeowners facing foreclosure (and want to hold onto their homes) and those who want to sell their homes (and find, with the housing slump, they are worth less than the mortgage value, and, lacking cash and credit, they are trapped).

This lifeline, though, needs a framework, mediation, and active state involvement to make it work.

The imprimatur (and the active assistance) of states’ attorneys general can make all the difference. By pressing mortgage servicing companies to modify loans before borrowers fall too far behind–by seeking their voluntary cooperation or by legally requiring lenders to seek mediation of troubled loans before they can foreclose–and, by offering a forum in which loans can be modified through mediation, they provide the means to implement a lifeline. The federal government should encourage and assist these efforts.
Lawsuits against mortgage lenders, investment banks and credit rating agencies may well be part of the states’ plans (to pursue litigation against those who inflated appraisals, for example, or failed to prevent the questionable packaging of loans into securities) but these actions, important as they are, do not provide immediate, if any, relief to homeowners. Mediation could.

The experience with the farm crisis that swept across the country in the 1980s–that led to a successful use of mediation of troubled farm loans—offers solid evidence that mediation can work. Farmer-creditor mediation brought debt-burdened farmers and their creditors together to resolve loan problems before they reached the point at which the only options were foreclosure or legal action. To address the staggering debt–farmers nationally owed $200 billion—and try to save a significant number of farms required a monumental effort, as crucial for creditors as for debtors.

Pioneering states, first in voluntary efforts, and, then through mandatory programs, instituted mediation. In Iowa, a state law prohibiting lenders from foreclosing on farms without first seeking mediation, created, also, the Iowa Mediation Service, which operated on the principle that even if farmers could not pay the full amount they owed, they often could pay something. In many cases, banks were happy to get that smaller amount instead of taking ownership of depreciating farmland. In the end, sixteen states, including Iowa, Minnesota and Texas, provided mediation services.

The U. S. Department of Agriculture assisted the states’ mediation efforts, moreover, by providing matching grants to states for farmer-lender mediation programs. Under the terms of the Agricultural Credit Act of 1987, federal lenders were required to participate in mediation of farm-credit disputes thus providing additional support and encouragement to the states.

These programs were evaluated, in terms of loans re-structured and paid off, satisfaction rates, and so forth, and deemed to be enormously successful, and, not only on tangible grounds. Farmers were able to remain on their farms and borrow again to keep their farms in operation (saving rural communities) and taxpayers and public and private creditors benefited as well. The emotional toll on family life that credit difficulties this basic can generate was lessened as well (e.g. domestic violence rates declined; divorce rates fell).

At the federal level, these programs were seen as being so successful that the USDA recommended to Congress that it consider extending the mediation process to include all federal creditors including the Internal Revenue Service and the Small Business Administration; U.S. Attorney’s offices were also included.

Now, some decades later, some states are moving to prevent home foreclosures following a similar path. The attorney general of Iowa, for example, hired that state’s mediation service to provide services for homeowners facing foreclosure on their homes much as that state provided to farmers and lenders years earlier. (Iowa is seventh from the top of states with subprime mortgage foreclosures at 9.4 percent).

As yet, though, no state is requiring mediation but when states’ attorneys general ‘encourage’ it, and when they see to it that the service is provided, there is pressure to use it.

There is no problem with capacity. States have a significant cadre of volunteer mediators who perform their services, in courts and in communities, as volunteers in some instances; professionals in private practice are available as well. They could gear up to offer mediation in homeowner-lender disputes. What is needed is an affirmative stance by each state’s attorney general to encourage (or require) the use of mediation prior to foreclosure, and, to provide the means to organize a systematic approach to provide the service, statewide.

Farmer-lender mediation programs provided solutions for the crisis in rural America only a few decades ago. The contemporary crisis in home mortgage foreclosures could benefit from a similar approach. It just may help families save their homes, preserve neighborhoods and communities, and help restore faith in the nation’s credit lending system.

Linda Stamato is a faculty fellow and Co-Director at the Center for Negotiation and Conflict Resolution at Edward J. Bloustein School of Planning and Public Policy, Rutgers University.

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