lllustration: George Peters

WASHINGTON — Mortgage giant Fannie Mae’s recent announcement that it will give homeowners facing foreclosure the chance to stay in their properties as renters for as long as a year is the latest aggressive move by the government to help troubled borrowers and tenants avoid being evicted. But as past efforts to stem the foreclosure crisis have already shown, even well-intentioned programs haven’t managed to reach significant numbers of people in peril – meaning any new approach faces a tough road ahead.

Consider, for example, a new federal law approved in May that protects renters from foreclosure evictions by giving them the right to stay in their residences after foreclosure for 90 days or for the duration of of their leases. Despite the new law, some tenants aren’t getting notice of their rights and are simply moving out, housing advocates said.

The problem has been particularly widespread surrounding a provision in the law, called the Helping Families Save their Homes Act, that allows for borrowers with Section 8 affordable housing vouchers the option to also stay in their residences when their landlord is in foreclosure. Some tenants who call their state or local housing authorities in Massachusetts and Connecticut after a foreclosure eviction notice are mistakenly told they have to move, noted Judith Liben, a senior housing attorney with the Massachusetts Law Reform Institute, a nonprofit legal services advocacy group. Better training of housing authority staff would help fix the situation, she said.

“Even with well-intentioned policies, there’s a disconnect between a good idea put into law, and what really happens on the street,” Liben said. “We see that disconnect on the ground, all the time.”

Despite anti-foreclosure initiatives by the government and lenders, the housing crisis has continued to worsen. Foreclosure notices totaled a record high of nearly 938,000 in just the third quarter of this year, according to RealtyTrac, an online foreclosure database. The Center for Responsible Lending predicts a total of 9 million foreclosures by 2012. Vacant and abandoned foreclosed properties are adding to neighborhood blight problems. Renters increasingly have become caught as innocent bystanders, evicted often without notice when their landlord faces foreclosure.

The new federal protections are supposed to address that. But in some cases, tenants in foreclosed homes either can’t reach real estate agents in charge of selling the properties to let them know they want to continue renting, or they get incorrect information from agents and think their only option is to move out immediately, said Shelley White, litigation director at New Haven Legal Assistance in Connecticut. In some instances, law firms send misleading letters that imply a financial incentive to move, known as cash for keys, is a renters’ only option, she said.

“We’re definitely seeing a lot of problems with tenants that just get notes from Realtors that say the bank has foreclosed on your property, and it’s time to get out,” Wright said.

The difficulties in outreach to tenants comes as the government continues expanding options and assistance to borrowers and renters dealing with foreclosure. In addition to the new federal law, the Treasury Department plans soon to rollout its plan encouraging more short sales by offering financial incentives to lenders and borrowers. In a short sale, a homeowner sells his home for less than the amount owed on the mortgage, and lenders forgive the remaining loan balance.

Both Fannie and Freddie Mac earlier this year began allowing qualified tenants in foreclosed homes under their control to sign month-to-month leases. Freddie Mac also started offering former owners of foreclosed homes the month-to-month lease option. Last week, Fannie announced its new policy, which significantly expands on the idea, allowing some owners who didn’t qualify for a loan modification and can’t afford their mortgage  the option of staying on in their homes. The owner would voluntarily turn over the property to Fannie in a “deed for lease” transaction, instead of going through a lengthy foreclosure process. The former owners in exchange would be given the option to rent back their homes for at least a year. Unlike in a short sale, their credit is unlikely to take a hit because of the transaction. And even investors may be eligible, meaning they would turn over their properties to Fannie, but their tenants would have the option to remain.

“This is huge,” said Dean Baker, co-director of the Center for Economic and Policy Research, who proposed a similar own to rent idea when the financial crisis first hit two years ago.

Baker would prefer that Fannie’s new policy extend the the rent-back period even further, to five or 10 years. But, overall, Baker said Fannie’s program addresses the problem of growing numbers of vacant properties, and represents a shift to promoting rental policies as a foreclosure solution. “You’re guaranteed a year, and that gives you some stability and a chance to plan ahead,” he said.

He and others also described Fannie’s new program as a big step forward over some efforts currently in place to help renters in foreclosed homes.

Fannie Mae, for example, already gives renters in foreclosed homes the option to continue renting on a month-to-month basis, or to accept a cash for keys offer. According to Fannie’s data, the financial help has been a far more popular option. Since January, it has tallied 3,500 cash for keys agreements, and 300 signed leases. Fannie Mae spokesperson Amy Bonitatibus said the program was set up to offer both choices to renters. It is open to all tenants of Fannie Mae-owned properties, but she had no information on specifically how many tenants had been approached with offers.

The small number of leases signed isn’t really surprising, said Danilo Pelletiere, research director for the National Low Income Housing Coalition. The options to renters were offered post-foreclosure, by which time some tenants may have decided to make other living arrangements. Cash for keys can be a more attractive option than a month to month lease. The new federal tenant protection law also overlapped with Fannie’s program, so some tenants may not have felt a need to sign leases, he said.

Pelletiere and other advocates said they have much higher expectations for Fannie’s new approach for former owners. A deed for lease transaction can happen far more quickly than a foreclosure, and having a longer-term lease will be more attractive to many people. Fannie also has hired a national property management company to handle the new program, while its existing rental initiative for tenants uses local real estate agents and property managers.

“Because of the way it’s designed, it should do a much better job,” Pelletiere said. “That makes it much more likely that we’ll see a national response. It provides a way for Fannie to be proactive and to get to the property earlier. And it costs less than getting someone out of a home and foreclosing on them.”

Alan Mallach, a senior fellow at the National Housing Institute and the Brookings Institution, agreed. “What’s interesting will be to look at how many people this new policy affects,” Mallach said. “I think it will be significant.”

Pelletiere said he also found some encouragement in early results from Freddie Mac’s program earlier this year to rent back properties to former owners of foreclosed homes on a month by month basis. According to Freddie Mac’s figures, almost 12,000 units entered its portfolio of foreclosed homes between April and October. In 70 percent of cases, a borrower is working on a mortgage loan modification, leasing the home back, or accepting cash for keys. In another 27 percent of cases, the property was vacant by the time Freddie Mac took it over. In three to four percent of cases, an owner or renter faced eviction. Of those occupants who signed leases, two-thirds were owner occupants and one-third were tenants. Spokesman Brad German said he had no further breakdown of the numbers.

The long-held belief has been that owners would decline to become renters again, so having more owners than renters sign rental leases is an encouraging sign for Fannie’s new program, Pelletiere said.

Still, he and others noted the government wouldn’t be prompted to move toward a more aggressive rental policy if a greater number of loan modifications were successful. A recent report by the Congressional Oversight Panel for the government’s taxpayer-funded bailout program criticized the progress being made under the administration’s Making Home Affordable program, saying that in a best case scenario it would prevent fewer than half of expected foreclosures.

As foreclosure notices pile up, troubled tenants and borrowers don’t always understand they might be eligible for help, or they don’t know who to contact to apply for programs, or they just give up and leave upon a foreclosure – even in cases where they have new federal laws and programs intended to avoid evictions. To Liben, the Massachusetts housing attorney, one constant of the housing crisis has been that some people “get lost in the shuffle.” She’s waiting to see if that will finally change.

Photo: Paul Demko, Minnesota Independent

Are housing foreclosures in Minnesota on the increase in 2009? According to RealtyTrac’s latest assessment of the housing meltdown, the answer is an unequivocal yes: foreclosure filings are up an eye-popping 71 percent over last year in Minnesota. Through August, more than 25,000 properties have been involved in foreclosure proceedings.

But the Hennepin County Sheriff’s Department has an equally stark statistic to prop up the case that foreclosures are actually on the wane in the state. The number of foreclosures that the law-enforcement agency has processed is down by 30 percent so far this year. In 2008 the sheriff’s department had auctioned off 5,198 foreclosed homes through August. By contrast, through the first eight months of this year it had auctioned off just 3,669 homes.

And Hennepin County is not alone. According to statistics maintained by HousingLink and the University of Minnesota’s Center for Urban and Regional Affairs, in 2009 there were 11,089 foreclosure sales through June, the latest period for which statistics are available. That’s down from 13,795 such sales in the first six months of 2008 — a decrease of 20 percent.

So what accounts for the radical difference in the assessments? Is one set of numbers bunk?

Not necessarily. For starters, it’s a difference in methodology. The system employed by the Minnesota housing groups is quite simple (if labor intensive): each month they call the sheriff’s departments in all 87 counties and find out how many foreclosure sales were processed.

“There’s no quibbling with that number,” says Dan Hylton, HousingLink’s research manager. “It is what it is.”

But RealtyTrac uses a more complex (and probably less precise) methodology to determine how many foreclosures are occurring across the country. It tabulates five different indicators of foreclosure and then adds them all together to come up with a grand tally.

“The data provided in the report counts the total new filings, consisting of Notices of Default, Lis Pendens, Notices of Trustees’ Sales, Notices of Foreclosure Sale and Real Estate Owned for the period requested on either a monthly, quarterly or annual basis,” reads a statement on the group’s web site explaining its methodology.

Since many homes go through several of these steps on the road to foreclosure, it’s highly likely that RealtyTrac is double-, or even triple-counting some properties. However, that still doesn’t explain the huge difference in statistics purporting to track the same trend.

At least part of the disparity can likely be traced to a difference in time frame. The statistics compiled by the Minnesota housing groups only run through June, while RealtyTrac’s study measures foreclosure filings through August. There was a lull in foreclosures earlier this year owing to moratoriums imposed by some of the country’s largest lenders.

But most housing experts expect a second wave of foreclosures during the second half of the year. While the initial housing crisis was largely due to irresponsible borrowing and dodgy mortgages, this next wave will be primarily homeowners unable to keep up with payments owing to the dismal economy. RealtyTrac’s numbers are likely more fully capturing the start of that next crest.

“The consensus among housing experts is that we’re in a lull between waves and that this next wave is going to be more economically driven,” says Hylton.

Minnesota Reps. Keith Ellison and Betty McCollum were the only two members of the state’s delegation voting against the measure. Reps. Tim Walz, James Oberstar, Michele Bachmann, John Kline, Erik Paulsen and Collin Peterson all supported the measure, which was attached to the student loans bill.

The Senate voted on an amendment Monday evening to block ACORN from receiving housing grants under the Transportation, Housing and Urban Development, and Related Agencies Appropriations Act. Minnesota Sens. Al Franken and Amy Klobuchar were among this voting in favor. The roll call was 83 yeas, 7 nays, and 9 not voting.

The vote came on the heels of a decision on Friday by the Census Bureau to eliminate ACORN as a community partner. The Bureau severed ties due the growing uproar over a sting operation by FOX News that prompted an ACORN employee to assist undercover FOX employees in setting up a small business for a brothel.

Rep. Michele Bachmann, who has been on a campaign to prevent federal funds for ACORN, was pleased with the news.

“I had written the Census Bureau again last week when these videos were released to reiterate my request that ACORN be removed from its census partnership program,” she wrote in an email to supporters. “I also wrote the IRS to ask for an investigation of their tax exempt status, to the Speaker of the House to ask for a Congressional investigation of ACORN’s activities, and to the Department of Housing and Urban Development to ask that it be debarred from HUD programs.”

She continued, “I am pleased that the Census Bureau has finally severed its ties with ACORN, but I will continue to work to see that this organization is no longer eligible for millions in your tax dollars.”

When none of those offers were accepted, GMAC took steps to have Williams removed from the property. The company gave her a check for $5,000 to help with relocation costs.

“GMAC Mortgage sincerely sympathizes with Rosemary Williams and the financial difficulties she is facing,” said Jeannine Bruin, executive director of GMAC Mortgage Communications, in a statement. “Friday’s actions were very difficult, and a regrettable end to 18 months of seeking a solution with Ms. Williams, with local non-profits and with the mortgage investor to keep her in the home on Clinton Avenue. Unfortunately, Ms. Williams was chronically unable to meet her payment commitments under the adjustable rate mortgage she originated with BNC Mortgage, Inc.

Here’s the entire statement from Bruin:

GMAC Mortgage sincerely sympathizes with Rosemary Williams and the financial difficulties she is facing. Friday’s actions were very difficult, and a regrettable end to 18 months of seeking a solution with Ms. Williams, with local non-profits and with the mortgage investor to keep her in the home on Clinton Avenue.

Unfortunately, Ms. Williams was chronically unable to meet her payment commitments under the adjustable rate mortgage she originated with BNC Mortgage, Inc.

Since December 2007, we have repeatedly extended options to Ms. Williams to reach an affordable, reasonable payment solution, while balancing our contractual obligations to the mortgage servicer and mortgage investor, Aurora Services and Lehman Brothers Holdings, respectively.

Our efforts included:

o Multiple loan modification offers to reduce her monthly payment by 30% and fix her interest rate.
o Two offers to purchase the property for as low as 48% of her unpaid mortgage balance.
o Two offers to lease the property for $850 per month, a 60% reduction in her monthly payment. One offer included a purchase option at 48% of her unpaid mortgage balance.
o Three offers of cash relocation assistance of $5,000, including a check payable to Rosemary Williams that was given to her Friday.
o Two rounds of negotiations with local non-profits to reach a purchase and lease agreement on Ms. Williams’ behalf.

As custodian of the property at 3138 Clinton Avenue, we were concerned about the breach of security and its potential impact on public safety and the integrity of the property. At our request, local authorities are enforcing the writ of eviction served on August 7 and removing all trespassers from the property, both now and in the future.

We stand by our actions knowing that we have consistently acted in good faith to find a solution for Ms. Williams, and have repeatedly tried to ensure that she has funding sufficient to secure temporary housing.

Photo: Paul Demko, Minnesota Independent

Minneapolis police officers removed Rosemary Williams from the home that she owned for nearly three decades on Friday afternoon. The 60-year-old grandmother had vowed to stay in the residence on the 3100 block of Clinton Avenue even after the home went into foreclosure and sheriff’s deputies evicted her from the premises last month. Williams almost immediately re-entered the property and continued to live there.

Her plight has become a rallying point for activists seeking a moratorium on foreclosures and more assistance for struggling homeowners. As Williams’ belongings were removed from the residence by supporters, at least 50 people gathered on the surrounding sidewalks. They chanted “Housing is a human right, eviction is a crime,” and “Not one more empty home, not one more homeless family.”

Photo: Paul Demko, Minnesota Independent

Shortly before 5 p.m. Williams peacefully departed the house carrying a few belongings. She ducked under the yellow crime tape that surrounded the street in front of her former home.

Photo: Paul Demko, Minnesota Independent

She was embraced by supporters who have kept a near constant vigil at her home in recent months.

Photo: Paul Demko, Minnesota Independent

Protesters then attempted to occupy the property and skirmished with police officers. Pepper spray was deployed to disperse the crowd.

Photo: Paul Demko, Minnesota Independent

About a half dozen protesters succeeded in planting themselves on the grass in front of Williams’ former home.

Photo: Paul Demko, Minnesota Independent

They were restrained with plastic handcuffs and arrested by the cops. At least one woman had to literally be carried away by the cops.

Photo: Paul Demko, Minnesota Independent

This woman continuously shouted “Who’s house? Rosemary’s house,” while she was being arrested.

By 6 p.m., seven protesters had been arrested, according to a release by the Poor People’s Economic Human Rights Campaign, which has supported Williams throughout the process.

Despite signs that the economy is slowly recovering, foreclosure levels across the country remain at near record levels. Last month default notices, scheduled auctions and bank repossessions were reported on 358,471 properties. That’s less than one percent under the record mark in July, but still 18 percent higher than a year ago.

Nevada continues to lead the nation in foreclosure rates: last month foreclosure filings were made on one in 53 properties in the state. Florida and California had the next highest rates.

Rep. Wilson. Photo: Wikipedia

I guess Rep. “Joe” Wilson (R-S.C.) — actually, Addison Graves Wilson, Sr. — found out about that secret Democratic plot to provide all illegal immigrants with free health care.

What else could explain his outburst — “You Lie!” — during President Obama’s speech on health care reform (video), responding to the president’s statement that “the reforms I’m proposing would not apply to those who are here illegally”?

Perhaps Wilson believes that illegal immigrants ought not get emergency medical treatment, which is the only medical benefit they might qualify for — when they show up in a hospital on the verge of death, for example.

Or maybe it’s just because Wilson’s last campaign was supported by the Americans for Legal Immigration PAC — a restrictionist group that supports deporting all illegal immigrants in the United States rather than offering any opportunities for legalization, or “amnesty.”

ALIPAC gives Wilson an “A” for opposing “amnesties and ‘guest worker’ programs for illegal aliens along with other rewards such as in-state tuition and driver licenses.” I guess because he supports keeping them uneducated and untraceable if they get into a car accident.

Meanwhile, as MSNBC’s Keith Olbermann pointed out on his show tonight, Wilson has been writing op-eds spreading the rumor that Obama wants to install “death panels” to hasten the death of grandma.

So who’s lying?

Photo: The Truth About..., Flickr

Just a year ago, the theory that poor and minority borrowers were to blame for the housing crisis took hold with a vengeance, and so did the belief that the government forced lenders to make subprime mortgages to meet affordable housing goals. The view took on greater prominence in the heat of a presidential campaign, and an obscure anti-redlining law known as the Community Reinvestment Act became a scapegoat for subprime lending and the collapse of the mortgage market.

Things have changed quite a bit since then, as the spotlight has shifted to lenders and their behavior during the boom. States and cities continue to aggressively pursue subprime lending discrimination suits, and judges across the country are signaling a willingness to move forward with some cases. As the lawsuits wind their way through the court system, more details and allegations about the inner workings of the subprime world are emerging. And as startling as some of the charges already have been — a former loan officer for Wells Fargo testified in one affidavit that employees regularly referred to minority borrowers as “mud people” and called subprime mortgages “ghetto loans,” — there’s even more ahead, said David Berenbaum, executive vice president of the National Community Reinvestment Coalition.

“The ’smoking guns’ are coming out,” Berenbaum said, referring to possible evidence that lenders targeted minority communities and borrowers for higher priced loans. “And I expect more and more of these smoking guns to become apparent.”

In the latest development, a Superior Court Judge in Los Angeles recently certified a 2005 lending discrimination lawsuit against Wells Fargo as a class action case. The suit contends that area managers at the bank refused access in some minority neighborhoods to a software program that allowed for discounted prices on mortgage loans. Barry Cappello, a partner with Cappello & Noel in Santa Barbara, which represents some 10,000 to 20,000 borrowers in the suit, said he believes it is the first subprime lending discrimination suit in California to be classified as a class action.

According to Cappello, Wells Fargo introduced a program in 2002 called “Loan Economics,” which gave loan officers the authority to offer discounts to loan applicants. The savings on lower fees and interest rates could be significant, ranging from $500 to as much as $10,000 per loan. The suit claims that the Los Angeles area Wells Fargo manager refused to allow loan officers operating in certain minority neighborhoods to offer the program. Borrowers in predominantly white neighborhoods were given access to the software.

Cappello said the suit stemmed from complaints by black and Hispanic loan officers for Wells Fargo, who said they asked to use the software in their branches but upper management refused.

Wells Fargo is fighting the suit and has denied all the charges. In a statement, the bank said, “We are disappointed in this ruling and intend to vigorously defend this matter as the case proceeds. The decision does not indicate the court believes the underlying allegations have any merit. We feel the allegations represent a complete mischaracterization of our long-standing commitment to responsible lending and the pricing practices and tools we use. The policies, systems and controls we have in place ensure race is not a factor in the pricing or products we offer.”

The case could go to trial in about a year, Cappello said.

More lawsuits are expected in the near future over the treatment of Hispanic borrowers in Arizona and Texas, who were offered high-cost loans they didn’t understand at misleadingly low teaser rates, then refinanced into even more expensive loans than their initial mortgages, Cappello said.

Wells Fargo, the nation’s largest home lender and Minnesota’s second-largest employer, also has been a target of lawsuits elsewhere. Last month, Illinois Attorney General Lisa Madigan sued the lender, alleging that blacks and Hispanics were sold high-cost subprime loans more frequently than white borrowers with similar incomes. The suit contended loan officers were offered incentives by the bank to steer borrowers into the more expensive loans, and that white borrowers generally received the lower-cost prime mortgages.

Some borrowers thought they were getting prime loans from Wells Fargo Home Mortgage, the suit also charged. But their loans actually came from Wells Fargo Financial, the bank’s subprime unit.

In Iowa, two watchdog groups charged this week that minority homeowners in Des Moines were three times more likely to receive high cost subprime loans from Wells Fargo than white homeowners.

In June, the New York Times reported on affidavits from a 2008 lawsuit by the city of Baltimore against Wells Fargo over subprime lending, which charged that the bank targeted blacks in Baltimore and suburban Maryland for high-interest subprime loans. Former loan officers testified in affidavits about using terms like “mud people” and “ghetto loans.” The bank also had an emerging markets unit that pinpointed black churches as fertile ground for selling subprime loans, according to the former officers. And in March, the NAACP filed suits in federal court in California against Wells Fargo and HSBC, alleging minority borrowers were more likely to be issued higher rate subprime loans than white borrowers with similar credit scores and qualifications. Both banks have strongly denied the charges. The NAACP also has pending litigation against nearly a dozen other banks and lenders over subprime lending discrimination.

Should all the charges in all the lawsuits be proven, it would amount to massive and violations of the Fair Housing Act, the Equal Credit Opportunity Act, and other fair housing and lending laws, Berenbaum noted. Enforcing fair lending laws has been “an issue the government has failed to address over the past decade,” he said. Lenders could face criminal penalties from the government for violating fair housing laws, and they could be subject to punitive damages and fines from government lawsuits.

Big lenders like Wells Fargo and HSBC are obvious targets for suits because of their size and the amount of lending they did. In addition, many other lenders and originators of subprime loans have gone out of business, complicating efforts to address allegations of lending discrimination through lawsuits.

That leaves a major question regarding all the lending still unanswered, Berenbaum said: Where has the U.S. government been? The Federal Reserve reported in 2005 that an analysis of federal mortgage data found that blacks and Hispanics were more likely to receive higher interest rates on mortgage loans – and that it intended to examine the practices of 200 lenders as a result.

But nothing’s happened since that announcement, Berenbaum noted. Instead, as the years go on, and the government takes no action, allegations about price differences in mortgage loans based on the race of borrowers and their neighborhoods continue to grow.

Mary Kane is an economy reporter for the Washington Independent.

Related: Wells Fargo: Minnesota’s No. 2 employer is No. 1 for targeting minorities with high-cost loans

Photo: iStockphoto

Two new studies reveal that the rate of “underwater” mortgages — that is, where the mortgage debt outweighs the current value of the house — is higher than previously believed, and point to further increases in the coming months.

According to real estate data firm Zillow, 23 percent of all single-family homes are saddled with mortgages worth more than the present value. Moody’s Economy.com offers a similar number; according to that company’s research, 24 percent of all homes have underwater mortgages, up from 15 percent a year ago. Additionally, another 8 percent of homeowners, while not technically underwater, have mortgage amounts that cancel out their equity.

This adds up to some 16 million homes, according to Celia Chen, senior director at Moody’s Economy.com. “Home prices have increased in the last month or two but I think it’s too early to call an end to the downturn,” she said.

That not-terribly-optimistic assessment might turn out to be an understatement. Investment bank Deutsche Bank released a report earlier this month saying that 48 percent — nearly half — of all home mortgages in the country will be upside-down by early 2011. According to Deutsche Bank managing director and global head of securitization research Karen Weaver, the historical rate of mortgage defaults has been about 7 percent. “However, that experience is of limited relevance because it’s from a period of much more moderate home price declines and stricter lending standards,” she cautioned in an emailed response to questions. In today’s economy, it’s more realistic to expect up to 20 percent of borrowers to default.

“This is a slow-motion second shoe to drop on the economy,” said Christopher B. Leinberger, a visiting fellow at the Brookings Institution. ” My concern is that it could be the catalyst for a W, or double-dip, recession. Sure, there are some green shoots but there are also these economic depressants that have to be dealt with.”

New research out of Northwestern University shows that even some homeowners who can afford to make their mortgage payments choose instead to default when their homes plummet in value relative to their mortgages. The study, which surveyed homeowners across the country last December and again in March, found that 26 percent of all defaults are what researchers termed “strategic.” Essentially, this means the homeowner actually has the money to pay his or her mortgage and deliberately decides not to. In parts of the country where home prices have lost a significant percentage of their value, these borrowers decide it’s worth the hit on their credit score to walk away from homes that might never again be worth what they paid for them.

According to Northwestern professor Paola Sapienza, one of the authors of the study, even homeowners who said in a survey that they have a moral objection to walking away from a debt change their mind if the ratio of their negative equity balloons. According to her research, when homeowners’ negative equity hits 50 percent — a not uncommon number in certain communities — 17 percent of homeowners will default, even if they can afford their mortgage payments. Since lenders very rarely sue homeowners for defaulting, the consequences for defaulting are generally limited to a battered credit score for a period of years. The danger is that, since each foreclosure drags down the values of surrounding homes, the number of borrowers handing the keys over to their lender could snowball as homeowners watch their neighbors default.

Worse, negative equity creates a ripple effect that extends beyond the affected homeowners. Even among those not trying to sell their homes or in imminent danger of foreclosure, the lack of a financial cushion in the form of home equity puts a damper on consumer spending. “A lot of people were feeling good about their wealth position,” says Economy.com’s Chen. Now that there is no equity, it’s having a negative impact on consumer spending.” Lower consumer spending leads to decreased retail sales, manufacturing slowdowns and, ultimately, job losses or reduced income. This, in turn, can prompt a new round of mortgage defaults, starting the cycle all over again.

This hurts lenders as well as homeowners. Despite the injection of government capital into banks, financial institutions — especially smaller regional or community banks —aren’t out of the woods yet. The TARP Congressional Oversight Panel said in its August report that banks are likely to need billions more in government support. Even with this aggressive intervention, some banks will still fail. Small and medium-sized community banks, especially those centered in areas that have been hard-hit by the real estate downturn, are the most likely victims. “It’s obviously a negative for banks,” said Economy.com’s Celia Chen. “I expect there will be more banks that go under.” Future bank failures will tax the already-strained FDIC. The agency’s most recent quarterly report revealed that its reserve, which it uses to pay depositors when banks fail, is down to $10.4 billion. Last year, the FDIC’s reserve was $45.2 billion.

Even when the economy strengthens and employment increases, negative equity makes it prohibitive, if not impossible, for homeowners to sell their homes. This will hamper an eventual jobs recovery if workers can’t move to where employers need them to be. “It has cause a significant issue in the relocation industry. People are reluctant to move,” said Joe Benevides, chair of Worldwide ERC, a workforce mobility association. “Employers are finding that their first choice candidate is not able to take relocation for financial reasons.” The time frame for relocating an employee, which includes the time needed to sell the worker’s current home, purchase a new one and complete a move had jumped. The process, which used to take between 120 and 180 days, now stretches from 180 days to as much as a year.

There’s no single solution to the problem of burgeoning negative equity, but industry analysts and policy experts say both short- and long-term fixes are necessary. Mortgage loan modifications are still discussed, although existing programs have barely put a dent in the foreclosure crisis. Some critics say this is because modifications so far have targeted interest rates rather than principal balances. Modifications that target principals are a double-edged sword, though; Casey Mulligan, a professor at the University of Chicago’s Booth School of Business, points out that homeowners may be incentivized to stop making payments on their mortgages if they think the threat of foreclosure will force the lender to cut them a deal. Mulligan suggests a simple solution would be to modify all underwater mortgages, although he concedes that this solution probably wouldn’t pass muster with already-beleaguered lenders.

Christopher Leinberger of the Brookings Institution believes some relief could come from public-transit investment. Since many of the most-troubled properties lie in far-flung exurbs of major urban centers, expanded public transit that makes it cheaper and more convenient for people to get to work in the distant city will increase property values. Leinberger says smart urban planning done around these transit hubs will also have a positive effect; in regions where tracts of single-family homes have been replaced by a mix of high-density residential units (such as apartment buildings) and retail space, property values go up and local tax rolls are bolstered by the presence of commercial property.

A major antidote will be the passage of time; many borrowers experiencing low to moderate negative equity will see investment in their homes pay off eventually. Unfortunately, there’s no way to create a fast-acting fix that mimics this effect. “For the most part, we have to let it happen. We needed a correction,” said Deutsche Bank’s Karen Weaver. “And, as we let the crisis play out, shore up the rest of the economy with low rates and government stimulus.”

Martha C. White writes about housing for the Washington Independent.