Secretary of The Treasury Henry M. Paulson, Jr., is in danger of becoming a household name in the midst of the sharp housing downturn. He is front and center in what has, to this point, been a tepid response on the part of the Bush Administration to rising defaults on subprime mortgages and the attendant layoffs of employees and the bankruptcies and/or closings of mortgage companies. In the last week or so, however, Paulson has been both speaking out and apparently doing a little maneuvering behind the scenes to try and address some of the problems.

On Monday we reported that three major banks were joining a consortium, primarily at Treasury Department urging, to pump money into markets for commercial paper. Then Tuesday Paulson, speaking before an audience of law school and business students at Georgetown Law Center made it clear in his prepared remarks that he thought the "ongoing housing correction" was not ending as quickly as might have been believed and hoped at the end of 2006. "And it now looks," he said, "like it will continue to adversely impact our economy, our capital markets, and many homeowners for some time yet. Even so, I believe we have a healthy, diversified economy that will continue to grow."



Secretary Paulson summarized the current situation and its impact on the economy. Housing starts are off more than 40 percent from the peak of 2.3 million units in early 2006; employment in residential building, including specialty trade contractors, has dropped by almost 200,000 since early 2006, offsetting about one-quarter of the jobs gained in the housing boom, and mortgage defaults and foreclosures are rising. At the end of the second quarter of this year, more than 900,000 subprime loans were at least 30 days delinquent. Foreclosures have increased about 50 percent from 2000 to 2006 and those involving subprime loans are up over 200 percent in that same period. Current trends suggest there will be just over 1 million foreclosure starts this year - of which 620,000 will be subprime.

"The housing decline is still unfolding," the Secretary said, "and I view it as the most significant current risk to our economy. The longer housing prices remain stagnant or fall, the greater the penalty to our future economic growth.

"So," the Secretary asked, "where do we go from here and what is the proper role for government?"

The first concern, he said, must be to keep as many homeowners as possible in their homes. Foreclosures are costly for borrowers, mortgage servicers, and investors and can cause whole neighborhoods to lose value. The second concern is the potential impact on the entire economy. "When (the involved parties) are relieved of the costs of bad decisions, they are more likely to repeat their mistakes. Still, we must recognize the very real harm to families affected by the housing downturn. "We must take steps to minimize the neighborhood effects and the macroeconomic effects of this housing market correction.

"Third, we need to identify public policy changes that will reduce the likelihood of repeating some of the excesses of recent years while maintaining access to credit for able homeowners. Yet, he said, "Today's mortgage market is different than in the past and it requires policymakers to think and act creatively.

"A first and important step is to bring mortgage servicers and the mortgage investors together in a coordinated effort to identify struggling borrowers early, connect them to a mortgage counselor and find a sustainable mortgage solution.

Recent surveys have shown that as many as 50 percent of the borrowers who have gone into foreclosure never had a prior discussion with a mortgage counselor or their servicer. That must change. Early intervention is critical - the earlier borrowers explore alternative options, the more likely they will find a workable solution and keep their home. We cannot expect to avert every foreclosure and, indeed, some are warranted. Even in years of strong housing performance, we witness several hundred thousand foreclosures. But today many homeowners out there can be helped, and we are committed to efforts designed to do just that."

The Secretary referred to Hope Now of which we wrote last week. This alliance of mortgage servicers, counselors, and investors is designed to coordinate outreach to homeowners to find solutions to their individual problems. He said that the immediate need is for more loan modifications and refinancing and other flexible methods for addressing problems. "The current process is not working well. This is not about finger pointing; it is about putting an aggressive plan together and moving forward. This alliance is dedicated to seeing that happen and I expect to see results. I also call on those servicers who are not yet a part of this alliance to join. You have an obligation to help meet this challenge, and you can do so more effectively as part of an integrated effort.

"Not all servicers," Paulson said, "are staffed for aggressive loss-mitigation. Preventing foreclosures is in investors' interest and investors must take an active role in demanding that all servicers, large or small, are pursuing all available loss-mitigation strategies. Today the industry doesn't have a thorough, standardized set of loss-mitigation metrics with which to evaluate servicers' performance. I expect the Hope Now alliance to quickly develop and begin reporting those metrics so investors, policy makers, and homeowners can measure results.

"There must also be steps taken to make more affordable mortgage products available for struggling homeowners." He cited President Bush's call on Congress to pass FHA modernization to make affordable FHA loans more widely available and to temporarily eliminate taxes on mortgage debt forgiven on a primary residence.

Paulson did not throw a bone to those hoping that the limitation of the portfolios of Freddie Mac and Fannie might be lifted. Instead he called on the two government sponsored enterprises (GSEs) to increase their securitization of mortgages - i.e. moving them out of their respective portfolios into the private sector - to increase the flow of capital into the credit markets. He stressed the particular importance of such securitization for loans designed to refinance borrowers out of current subprime mortgages.

In the realm of policy changes Paulson suggested homebuyer education and effective ways of disclosing the impact of loans and terms were key to protecting homeowners. "We must identify what information is most critical for borrowers to have so that they can make informed decisions. At closing, homebuyers get writer's cramp from initialing pages and pages of unintelligible and mostly unread boilerplate that appears to be designed to insulate the originator or lender from liability rather than to provide useful information to the borrower. We can and must do better."

But borrowers must also do their part and cannot be excused from their obligation for due diligence. Homebuyers have a responsibility to understand their mortgages.

The Secretary also criticized the fragmented regulatory and enforcement authority across and among state governments and federal agencies as a "patchwork structure (that) should be streamlined and modernized," and called for regulation and licensing requirements for mortgage brokers that will reveal prior fraudulent activity and require proper training and education.

While his first steps have been tentative, that Secretary Paulson is addressing the housing situation at all is reassuring. He does not seem to share the Administration's determination to let the private markets that created the problems in the first place now solve them. His current solution seems to involve talking the big players in the market into positive action but one can sense that he is not going to let the issues arising out of the housing downturn further endanger the economy before taking stronger measures.