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Indiana University

SPEA policy brief addresses problem of 'underwater' mortgages

June 1, 2010
Bloomington, Indiana --

A new policy brief from the Indiana University School of Public and Environmental Affairs finds no obvious answers for the millions of American homeowners who are "underwater" on their mortgages, owing more than their property is worth.

Ashlyn NelsonWriting in the May 2010 issue of SPEA Insights, Ashlyn Aiko Nelson, an assistant professor at IU Bloomington, notes that the federal response, focusing on stabilizing the financial sector and encouraging the modification of some problem mortgages, has done little to curb the rise in mortgage defaults and foreclosures.

"There is a growing realization among federal policymakers, mortgage lenders, and servicers, as well as underwater borrowers themselves, that existing loan modification programs are insufficient and only more drastic measures will stem the surge in mortgage defaults," Nelson writes. "Yet questions remain about how best to solve the problem, and whether taxpayers will be able to stomach the cost of additional loan modification programs."

The policy brief, accompanied by a video segment in which Nelson explains the concept of "underwater" mortgages, is part of a monthly series in which School of Public and Environmental Affairs faculty write about their areas of research and expertise. It is available online at http://www.indiana.edu/~spea/about_spea/SPEA Insights.shtml.

Nelson explains that the underwater mortgage crisis developed from a rapid expansion of home ownership opportunities, followed by sharp declines in housing prices that had reached a peak in mid-2006. By the end of 2009, American households had lost $7 trillion in real estate wealth, 13.6 percent of U.S. mortgages were delinquent, and more than 5 million households were at risk of foreclosure. The results have included financial hardship for families, depressed housing prices and, at the macro level, reduced solvency for financial institutions and a slowing of economic growth.

"The federal government now has the unenviable task of designing policies to keep underwater mortgages from undermining economic recovery," Nelson writes.

Recent estimates say as many as one in five U.S. households with mortgages are underwater; and the problem is considerably worse among recent homebuyers and, especially, those who relied on subprime or reduced-documentation mortgages.

The Obama Administration has responded with the $275 billion Home Affordable Modification Program, which offers incentives for lenders to modify mortgages, but the program has helped only a small percentage of delinquent borrowers. Some experts have argued that it would be more effective to forgive loan principal than to modify mortgage terms. Recently, Bank of America and the U.S. Treasury Department announced programs to forgive or write down the principal on some underwater mortgages.

"Whether these new programs are effective -- or induce moral hazard by creating additional incentives for borrowers to default, as some critics warn -- remains to be seen," Nelson writes.




Web version:
http://newsinfo.iu.edu/news/page/normal/14588.html?emailID=14588