For some time now it has been becoming clear that the Obama administration's year-old effort to pump life back into the housing market was falling short even before some of the biggest lenders suspended their foreclosure proceedings because of faulty paperwork.
The federal government just reported that some 10.9 million borrowers are underwater and another 4.2 million homeowners are "seriously delinquent" on their mortgages. There's also the threat of protracted litigation between borrowers and banks because lenders might not have followed the letter of law in processing foreclosure paperwork.
Even more of a worry is that sitting on the balance sheets of Bank of America, JPMorgan Chase, Wells Fargo and Citigroup is $426 billion of so-called second liens - home equity loans and second mortgages that are also attached to borrowers' primary mortgages.
If you add it all up there's a chance that the U.S. housing market could languish in a slump for years to come.
The good news is that no matter how bleak this may all sound, there may be a way out that does not involve yet another government bailout.
To some housing experts, lawyers, mortgage traders, securities experts and others, there is a unified agreement on what a solution to the mortgage crisis might look like. The solution must allow many borrowers to stay in their homes, compensate disgruntled mortgage investors and allow banks to take writedown loans without causing a repeat of the financial crisis of 2008.
Barbara Novick, vice chairman at BlackRock Inc, the world's largest money management firm said recently, "In the end, everyone has got to give a little and that includes investors, banks, homeowners and regulators. We want to keep as many people in their homes as possible, but there isn't a free lunch. We want to keep losses manageable for the banks, but enforce principles of contract law as well."
While all sides need to cooperate, there is still a large disagreement on what solution it might take to end this mess. There's going to have to be a large compromise.
To some, banks should take bigger writedowns on home equity loans, especially if bond investors must assume any losses from a principal writedown on the underlying mortgage.
After being propped up by U.S. taxpayers and then spending the past year building up capital, banks are hardly wanting to take yet another round of writedowns and charges.
Bill Frey of Greenwich Financial Services, a firm that specializes in mortgage investing said, "To ultimately resolve this, you are going to have to come up with some solution for the second liens the banks own because no one wants the banks to fail, but the banks are going to have to write down second liens."
One possible solution to handle the home equity loan issue would be for the regulators to allow banks to spread out their writedowns over the course of many years. Another idea would be to force the banks to take the hit at all once, but have the government provide a loan that is paid down each quarter from the bank's reserves.
However, experts say that once banks are forced to deal honestly with their home equity liability, it makes it easier for other parties to take their lumps as well and come up with creative solutions regarding the mortgage mess. Then investors in mortgage-backed bonds would be less likely to refuse principal reductions on primary mortgages held by borrowers without much cash.
Banks that are willing to take a hit on second liens would make it easier to devise a rescue plan that folds the mortgage and home equity loan into a single low-interest rate loan with a reduced principal obligation.
As a result bond investors may be more flexible on negotiating a resolution with banks on claims that lenders are obligated to buy back home loans that were flawed from the start because of either defective paperwork or faulty underwriting standards.
Bill Frey suggested that instead of a cash settlement with the banks maybe mortgage investors would be receptive to receiving preferred stock in a bank.
Today, the business of packaging loans into asset-backed bonds has a bad reputation. Collateralized debt obligations combined together from bonds backed by subprime mortgages may go down as one of the worst forms of financial engineering in history.
However, not all securitization is bad because it allows banks to free up capital to provide additional lending. Today securitization remains in a slump because private bond investors remain wary after getting burned on collateralized debt obligations and because of the dispute with banks over allegedly faulty underwriting standards during the mortgage boom.
Chris Katopis, executive director of the Association of Mortgage Investors, a bond investor lobby whose members include Fortress Investment Group and DoubleLine Capital said, "There are two sides to this, which is first untangling the mess and then the question of how do we restart securitization and move forward. There are common themes to dealing with both these issues in terms of transparency and better representations and warranties by banks on mortgages."
At the same time, for some homeowners who are currently over burdened with a tremendous amount of debt a reduced mortgage won't make much of a difference, while some agree that it may require the government or banks to provide rent subsidies and possibly relocation money until those borrowers can get back on their feet.
Janet Tavakoli, a Chicago-based derivatives consultant who has been a long-time critic of the way banks packaged and sold mortgage bonds during the housing boom said recently, "We're years late in dealing with this and that has made the problem much worse. Entire neighborhoods are devastated and many innocent homeowners with sound mortgages are underwater."
Tavakoli offered a solution that included a fund to subsidize rents for foreclosed borrowers which could be financed "with fines, penalties and judgments" stemming from a resolution of litigation over faulty loan documentation.
Law professor Michael Madison said he sees the need for the government to step in and help out some borrowers. "This talk about a foreclosure moratorium is just going to make the housing crisis worse because it disables the banks in retrieving properties and selling them. But in some cases, this isn't going to get solved unless the federal government comes in and subsidizes the borrowers."
However, in today's political environment anything that sounds like a bailout may be a tough to sell, even impossible. But if all responsible parties to the mortgage mess could give just a little, it might require U.S. taxpayers to chip in once again.
The alternative of doing nothing and waiting for the economy to bail out the housing market seems dim.
Robert Shiller, Yale University economics professor and co-creator of the S&P Case Shiller Index, which monitors the nation's housing market said, "This high unemployment equilibrium could last for years. If you are going to deal with this in the short run, you are going to have to violate contracts. What is more worrisome than the recession itself is that the government doesn't seem to represent the people anymore."