How to Mitigate the Pain of Foreclosure

Equity Private has a bright idea for how to help mitigate the worst effects of the housing mess: include mortgage debt in bankruptcy proceedings. She doesn't go into a lot of detail – that's promised for later today – but I assume the idea is that the lien on the property would remain, but that the principal amount of the mortgage could be written down.

Certainly, such a proposal would avoid the costs of foreclosure, which is expensive for lenders and disastrous for homeowners. But I do fear for the unintended consequences of messing with the very foundations of secured lending.

I'm still a fan of the proposal from Dean Baker and Andrew Samwick. Allow lenders to take possession of the property, but allow the (former) homeowner to continue to live in it, paying a market rent. The costs of foreclosure to the homeowner are minimized, while the lender continues to get an income from the property as well as owning it outright.

I suspect deals like that will happen more frequently as the foreclosure rate rises, even if they're not mandated by law. Lenders at the moment tend to be inflexible and unimaginative in foreclosure situations, but sooner rather than later they're going to realise that they're shooting themselves in the foot and that owning a large inventory of empty, unsold, and borderline-unsellable homes is not a business they really want to be in. In other words, even if Congress doesn't step in, the market just might find a sensible solution on its own.

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