The government is moving closer to implementing a plan to guarantee two million to three million at-risk mortgages in return for an agreement from lenders to engage in systematic loan modifications.

Federal Deposit Insurance Corp. Chairman Sheila Bair revealed Wednesday that her agency had already worked out a key detail: a standardized loan modification program.

Though she said discussions with the Treasury Department about whether to use it remain ongoing, Bair said the agency has "developed … a federal program to help more borrowers avoid foreclosure."

"This program would provide economic incentives for lenders and loan servicers to modify loans, along with a framework" to put borrowers "systematically into long-term, sustainable, affordable mortgages," Bair said during a speech at a conference hosted by the FDIC. "Such a framework is needed to modify loans on a scale large enough to have a major impact."

The Treasury has not formally agreed to implement the program, though sources said officials support the idea.

The Office of Management and Budget, which must sign off on any government expenditures, is still reviewing the plan, however, and has raised objections. Sources said the OMB has ideological and cost concerns, though they said the issues could be resolved relatively quickly.

Overall, the plan is expected to cost the government $40 billion to $50 billion; the money would come from the $700 billion Congress gave the Treasury as part of the massive rescue bill.

However, the program could guarantee much more than $40 billion to $50 billion of mortgages. The Treasury would guarantee loans that meet certain criteria in return for an agreement from lenders that the loans would be modified according to government standards. If a modification worked and the loan did not default, lenders would continue to own the mortgage. If the modification failed and the loan went into foreclosure, the Treasury would pay the lender a certain percentage of the loss. Details on exactly how this would work are still being discussed.

A representative from OMB did not respond to requests for comment.
A Treasury spokeswoman said the administration "is looking at ways to reduce foreclosures, and that process is ongoing. We have not decided on a particular approach."

An FDIC spokesman said it has had "productive conversations with Treasury" about the program, but "it would be premature to speculate about any final framework or parameters of a potential program."

The loan modification plan appears similar — but on a much larger scale — to the FDIC's management of IndyMac Bank's loan portfolio. After taking over the failed $32 billion-asset Pasadena, Calif., thrift July 11, the FDIC began a systematic loan modification program. It suspended foreclosures there and offered some borrowers new loans with rates capped at 6.5%. Borrowers must meet standard criteria to qualify for a modified loan, including a 38% debt-to-income ratio.

At a Senate Banking Committee hearing last week, Bair said 40,000 IndyMac borrowers have been deemed eligible for the modifications. "Our hope is that the program we announced at IndyMac Federal will serve as a catalyst to promote more loan modifications for troubled borrowers across the country."
In her speech Wednesday, she said the housing crisis will not end until policymakers focus seriously on stemming foreclosures.

"Once we get ahead of the curve on foreclosures, we'll be able to see the light at the end of the tunnel, but we will not be able to see that light until we do get ahead of the curve on foreclosures," she said.

Also at the conference,  Bair said policymakers need to follow temporary measures implemented during the credit turmoil — including the FDIC's expanded coverage of deposits and unsecured debt — with a long-term tightening of lending rules.
One critical driver of the crisis was a regulatory system that applied differently to banks and nonbanks, Bair said.

The expanded deposit coverage and other responses to the crisis "are all essentially emergency measures," she said. "We need rules and means for enforcement of those rules that apply across the board — no exceptions.
"Mortgage lending standards are the obvious example," Ms. Bair said. "What got us into the mess we're in is regulatory arbitrage, with different rules for banks and for nonbank lenders. … Leverage and transparency are two other areas where we need smarter regulation."

Regulatory reform — a subject lawmakers are likely to take up in the next Congress — could also cut down on the overlapping duties now confronting multiple agencies, she said.

"I also think we need to modernize our regulatory structure to match the growth, expansion, and complexity in our markets," Bair said. "Our system remains too balkanized, providing an open invitation to the regulatory arbitrage that drove our current problems."

Regulatory reform may take time to implement, she said, but tighter regulation for financial institutions is a more pressing concern.

Reforming the structure "will likely be a top priority for the incoming U.S. Congress next year," she said. Nevertheless, "now is the time, I believe, to get back to basics with common-sense rules to protect borrowers, constrain leverage, and provide greater transparency."

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