Imagine that you (like six other homeowners on your block) are hopelessly behind on your mortgage payments. You can't sell the house; the market is glutted. Anyway, there's no point in trying because the mortgage balance exceeds the value of the dwelling.
What to do? Nothing much, except to watch the neighborhood go to seed and wait for the sheriff to show up.
Unless, that is, you are one of the (relatively) lucky 1,000 mortgage customers of Bank of America who will soon be offered a deal in which owners in default sign over their houses to the bank in return for the right to rent them back for three years at the market rate or below. That's a trade in which everybody wins, and it raises a trillion-dollar question: Why didn't BofA, and every other bank, try this three years (and 8.4 million foreclosures) ago?
Think how sweet an arrangement this could be. An ex-homeowner gets to stay put for years, provided, of course, the household can afford the rent. No need to move the kids to a new school, to face the humiliation of eviction, or to find another place to live. The bank, for its part, skates past the hassle and cost of foreclosure (which averages about 5% of the face value of the mortgage). It also avoids the problem of selling quickly into a dismal market or managing an unused property that is catnip to vagrants and vandals. As a bonus, the deal generates some income.
The neighbors win, too. Nobody wants to live in a sea of unoccupied property decorated with "For Sale" signs. Even the broader community comes out ahead because additional rental housing would reduce rental rates.
The idea of renting to owners in default, which has been kicking around since the Depression, was revived by economist Dean Baker of the Center for Economic and Policy Research in 2007. The Federal National Mortgage Association, Fannie Mae, has actually had a modest "deed for lease" program on the books since 2009 (but doesn't publicize it much).
So why has it taken this long for a big bank to try it? We can conjure a number of reasons. In a bow to the real-estate lobby, Congress long ago barred lenders from going into the rental business. Yet banks do have the legal right to lease properties they acquire through default for up to five years. And if banks had good reason to fear regulators swooping down if they embarked on a rental initiative, they surely aren't worrying now. In January, Federal Reserve Chairman Ben Bernanke issued a white paper on housing fixes that leaned heavily on the idea of easing the glut of homes for sale by channeling them into rentals.
The real problem, we suspect, is the banks' worry about precedents -- that if they offer to rent to some owners in default, public opinion may force them to offer the same deal to all. Then there are the issues of who sets the rent, and whether obstinate tenants can be evicted if they get behind on payments or when their leases expire.
More than likely, then, banks need a push. To this end, regulators could certainly push them, but such micromanagement would generate its own problems. The Obama administration, for its part, could press Fannie Mae to expand its deed-for-lease program, reaching out to mortgagees in default and offering them more than the current one-year lease deal.
Probably the best approach would be legislation that clarified the rights of banks and owners in default in the rental market, and created mechanisms for setting rental terms and eliminating ambiguity about rental-contract enforcement. The only bill we know about that addresses the issue was introduced in 2010 by Rep. Raul Grijalva, a Democrat from Arizona. But that bill only confirms the banks' suspicions about losing control of their property: It would give every homeowner in default a "right to rent" for five years, and give the courts discretion to set rents.
It's fair to say that Mr. Grijalva's right-to-rent bill is going nowhere in Congress. But legislation limited to encouraging rentals to owners in default ought to be palatable across the ideological spectrum. Would that be too much to ask of a bitterly divided Congress in an election year?
It's a long shot, but surely worth trying. How many other ideas are out there that would help all parties in the housing-market bust, yet cost the government nothing? In the meantime, we can only hope that Bank of America expands its program, and that other lenders have the courage to follow its lead.
Mr. Barth is a fellow at the Milken Institute and co-author of "Fixing the Housing Market: Financial Innovations for the Future" (Pearson Prentice Hall, 2012). Mr. Passell is a fellow at the Institute and editor of the Milken Institute Review.
