G ov. Arnold Schwarzenegger has grasped a fundamental fact: Unless California boldly addresses the root cause of the problem, rising home foreclosures, the economy and state revenues will continue their downward spiral.
As part of the emergency special session he called on Thursday, Schwarzenegger has proposed immediate foreclosure relief and long-term mortgage reform. As David Crane, the governor's special adviser for jobs and economic growth, said Wednesday, to protect the California economy, the state needs to keep more people in their homes. So the administration has crafted a proposal to encourage lenders to do more loan modifications.
The key element is a 90-day stay on foreclosures unless loan servicers adopt a "robust modification program" similar to the one pioneered by the Federal Deposit Insurance Corp. after it took over California-based IndyMac Bank.
Under that model, the lender (or its loan servicer) goes through all loans where borrowers are 60 days late and paying more than 38 percent of income in monthly payments. These loans are reworked with lower interest rates, longer terms or smaller principal amounts so that a borrower's monthly payments for principal, interest, taxes and insurance equal no more than 38 percent of income.
This model is a good starting point.
And as an incentive to get more servicers to adopt this comprehensive program of mass loan modifications, the governor's proposed 90-day stay on foreclosures is an important step.
But the proposal has serious weaknesses that legislators will have to remedy:
• If servicers don't follow through on their modification programs, there's no accountability. The plan has no public reporting of loan modifications by specific servicers. Legislators should insist that any loan servicer that wants to avoid the 90-day stay on foreclosures must provide information on loan modifications that will be publicly reported.
Only through sunshine can the public see which servicers are actually doing the needed loan modifications. This requirement should apply equally to all servicers sending out notices of default in California, whether licensed by the state or federal government, because regulating foreclosures is the province of the states. There is no federal foreclosure law.
• The governor's plan does nothing for borrowers not yet late in their payments. This provides a perverse incentive for people to skip payments.
Legislators should insist that the plan include borrowers with adjustable-rate loans who could soon fall behind in payments when rates reset, as well as those who are making only minimum payments that increase (rather than decrease) their loan balance over time. JPMorgan Chase & Co. already has announced it will do this.
No one should doubt the need to act during the special session. Until the state addresses rising home foreclosures, the revenue bleeding will continue – and the state's budget mess will continue to get worse. The governor and legislators need to staunch foreclosures and do it now.
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