Wharton Professor Embraces Two Major Provisions — Sees Hope for a Third

The Obama Administration's plan for reducing the number of foreclosures is "extremely smart and very wise," says Wharton real estate professor Susan M. Wachter. Two of the three parts of the plan are particularly appealing, she says, adding that even the third might turn out to be more of a success than its many critics contend.

Wachter applauds the plan's provision for the Treasury to make $200 billion available to Fannie Mae and Freddie Mac, which, combined with the Federal Housing Administration, back about 90% of residential mortgages in the U.S. That level of support is "a clear statement that the Treasury stands behind Fannie and Freddie," which should provide them with better rates from the capital markets.

Also, Wachter likes a provision that sets a more liberal loan-to-value ratio for refinancing mortgages. Previously, Fannie and Freddie would require costly private mortgage insurance to refinance a loan that represents more than 80% of the underlying property's value. The new rules permit borrowers to take out loans for up to 105% of a property's value, if the applicants are up-to-date on their current mortgages. That provision, she said, will help people who are underwater on their mortgage, meaning they owe more than the value of their home — a frequent result of precipitous drops in the real estate values. "For many of these people, the refinancing will also put money in their pockets," which would help the broader economy by encouraging those consumers to spend more.

Wachter says the third part of the plan "is the most questionable and understandably gets a lot of criticism." It provides $75 billion worth of incentives for lenders to modify loans so that the payments amount to no more than 38% of a distressed home owner's income. A contribution from the government would reduce the amount to 31%. Critics say the financial incentives may not be great enough to encourage many banks to participate. But Wachter notes that banks which do not participate in the plan may be more likely to become subjects of the government's "stress tests" — reviews of their solvency required by the latest bank rescue plan. Banks failing the test could be declared insolvent or be forced to accept a cash infusion from the government's Troubled Asset Relief Plan, which comes with strings attached, such as executive compensation limits. "So the question that non-participating banks have to ask themselves is, 'Do I want to be first in line for a stress test?'"