FORECLOSURES can ravage local communities and local governments. When houses stand unoccupied week after week, weeds grow, windows get vandalized and paint peels. The deterioration of even one house can hurt neighbors' property values, which in turn makes their houses harder to sell or refinance, raising the risk that they, too, will default on their mortgages. Meanwhile, officials spend more on maintenance -- while taking in less in property taxes.
With foreclosures mounting in many states, limiting the harmful side effects is an urgent problem. The question is what to do about it. One proposal is to have government buy distressed properties, then turn them over to private, nonprofit groups for use as low- and moderate-income housing. Some such programs have worked well, and the Senate housing bill includes $3.9 billion to expand them dramatically, with the money to be distributed via state and local governments. The House had backed away from the idea because of opposition from Democratic deficit hawks and a White House veto threat. But when Treasury Secretary Henry M. Paulson Jr. demanded that Congress attach a Fannie Mae-Freddie Mac rescue plan to the housing bill, House Democratic leaders sensed that they had fresh leverage -- and reinstated the money, provided that it can be offset through additional revenue or spending cuts.
The administration's main objection is that the plan is basically a bailout for banks. That point has some merit, as does the concern expressed by some conservatives that state and local governments will steer the money to political allies. The history of public-private low-income housing partnerships features both success stories and taxpayer rip-offs. It is no accident that the authors of the bill included a provision denying money to anyone who has been indicted under federal campaign finance law. Still, most nonprofits are legitimate organizations concerned that, without socially minded interventions, investors will eventually buy up today's foreclosed-on properties and "flip" them with little concern for neighborhood stability.
Our main problem with the proposal is that it may give lenders a perverse incentive to foreclose. Ordinarily, the costs and risks of foreclosure, including the risk of getting stuck with unmarketable properties, force banks to avoid foreclosure whenever they can. But that deterrence will be weakened if state and local governments suddenly appear on the scene with almost $4 billion to spend on homes that have been foreclosed on. This would not be a concern if the plan were restricted to properties that had been foreclosed on prior to its adoption, but it does not have such a restriction. Without that limitation, the plan shouldn't pass.