For much of the last year, Washington officials have been pressing the mortgage industry to modify home loans and avoid foreclosures. Now, the extraordinary government intervention in Fannie Mae, Freddie Mac and a growing number of banks puts federal agencies in the powerful, and awkward, position of deciding which borrowers will receive help and who will lose their home.
And while the Bush administration is leaving it to the next president to decide how the mortgage finance companies will operate further out, the actions taken by their conservators now will have an immediate influence on the cost to taxpayers — and to the economy — of stabilizing the nation’s fragile housing market.
Regulators are walking a fine line between protecting the government from losses and helping struggling homeowners and the broader economy, according to financial and political analysts. If officials modify too many home loans or the companies suffer high defaults on modified loans, taxpayers will be stuck with an inflated bill. But doing too little might prolong housing market problems.
“You are trying to strike the balance between the duty to protect the assets of the organization,” said Alex J. Pollock, a senior fellow at the American Enterprise Institute, “and the sensible policy of trying to control the downward momentum of the housing bust.”
Politics will also play a role as the November presidential election draws closer, not least because the rescue plan engineered by Treasury Secretary Henry M. Paulson Jr. defers important decisions about the companies’ missions for the next president and Congress. Both presidential campaigns have supported the takeover of the companies, but they differ significantly on what should be done with them in the future.
For now, the federal budget will not include Fannie’s and Freddie’s liabilities, the Office of Management and Budget said on Friday. Including the debts on the government’s books would have doubled the national debt.
On Thursday, four Democratic senators called on the Federal Housing Finance Agency, the regulator now in charge of Fannie Mae and Freddie Mac, to give some breathing room to defaulting borrowers by imposing a three-month moratorium on new foreclosures for loans owned by the companies. The Bush administration opposed calls for a similar moratorium by Senator Hillary Rodham Clinton earlier this year.
Mr. Paulson later persuaded some big lenders to give delinquent borrowers an extra month to negotiate modification or repayment plans before seeking foreclosure. As they prepare to go large-scale, regulators have been keeping an eye on how the Federal Deposit Insurance Corporation, which oversees failed banks, does things. The agency has taken several steps to make it easier for struggling borrowers to repay their mortgages and stay in their homes.
Last month, it began offering 25,000 customers of IndyMac Bank — which became one of the largest failed financial institutions in American history — lower-priced, fixed-rate loans if the borrower could afford to make payments. It offered to trim interest rates on loans to as little as 3 percent in some cases, and gave a number of borrowers up to 40 years for repayment.
Sheila C. Bair, the chairman, has been one of the most vocal proponents of wide-scale loan modifications since last year, when defaults on mortgages started rising sharply. A spokesman for Ms. Bair, Andrew Gray, said the efforts were still in the early stages, but the F.D.I.C. had been pleased with the results so far.
But the challenges for Fannie Mae, Freddie Mac and their regulators are on a different plane. How the Federal Housing Finance Agency decides to approach loan modification will have ripple effects through the economy, because the two companies together own or guarantee nearly half of all loans outstanding.
The director of the F.H.F.A., James B. Lockhart, has said he wants the two companies to be “creative and aggressive” in modifying loans, but he has not offered or endorsed any specific plans since he took their reins.
For the moment, only a small faction of loans controlled by the companies are delinquent or in foreclosure. But defaults have been rising fast, especially among a category of loans known as Alt-A, which are riskier than conventional prime loans. Many of these did not require borrowers to provide proof of their incomes and assets.
Before the government seized them, Fannie Mae and Freddie Mac had already advanced their efforts to modify loans. In July, the companies said they would pay the mortgage servicing companies that deal with borrowers on their behalf a double bonus to help arrange loan modifications. Fannie Mae has also been making personal loans to help borrowers with temporary financial problems catch up with past-due payments.
The government has, of course, overseen large programs for delinquent mortgages before. In the banking crisis that struck the economy in 1980, the F.D.I.C. and later the Resolution Trust Corporation took over many failed banks and savings and loans. But that is where the comparison ends: most of the problems then were concentrated among a relatively small number of commercial mortgages. It will be harder to deal with millions of home loans, said William M. Isaac, a former chairman of the F.D.I.C.
“When I make a judgment about commercial loans,” Mr. Isaac said, “it’s just a handful of commercial loans.” He says he believes the government will need to impose general rules and monitor how mortgage companies apply them to borrowers.
To make matters worse, a large number of mortgages made during the recent housing boom are unsalvageable because borrowers cannot afford even the terms of modified loans. Many of these will default yet again after they are altered, said Bert Ely, a financial consultant who has been critical of the F.D.I.C. modification plan.
“If you do a bunch of mass modifications with borrowers who still can’t handle the modified loans for any number of reasons, all you have done is rolled the foreclosure into the future,” Mr. Ely said.