The proposal would be part of a “stimulus” bill Senate Banking Committee Chairman Christopher J. Dodd suggested be made to invigorate the housing sector and overall economy as widespread foreclosures are hindering state and local governments’ revenue and their ability to deal with the challenges locally, according to a letter Dodd issued Tuesday to U.S. Senate majority leader Harry Reid.

“The collapse of the housing market is a prime cause of the economic problems that we are facing today,” Dodd said in the letter. “Housing prices are falling on a national basis for the first time since the Great Depression. Delinquencies are growing, and foreclosure rates are at historic highs and likely to grow further, affecting as many as 2 million families directly and millions more through depressed housing prices and reduced home equity.”

“In light of these facts, I believe that any stimulus package must address the problems that confront the housing market, distressed homeowners and their communities.”

Dodd’s proposed Federal Homeownership Preservation Corporation would purchase outstanding mortgages at steep discounts. Lenders and investors would take a “haircut” and the discounts would be passed to borrowers in the form of new, lower-balance, 30-year fixed-rate mortgages backed by the Federal Housing Administration or the government-sponsored enterprises, the letter read.

He will suggest initial capitalization of $10 billion to $20 billion for the corporation. Funds and coverage for possible losses would be generated from the difference between the old mortgage and the new mortgage, Dodd said.

Dodd’s proposal appears to be modeled after a Depression era program that, according to a recent report, was very successful.

In 1933, the government created the Home Owners’ Loan Corporation as a temporary solution to refinance defaulted mortgages, while relieving borrowers from excessive payments, placing the least possible burden on the U.S. Treasury and protecting investors, according to the Crisis Intervention in Housing Finance: The Home Owners’ Loan Corporation. It was funded with $200 million and authorized to issue $2 billion in government-guaranteed bonds for the defaulted loans it would acquire from lenders and investors to then refinance to more favorable terms.

At the time the Home Owners’ Loan Act of 1933 was drafted, about half of mortgage debt was in default, unemployment had reached about 25 percent, thousands of banks and savings and loan institutions had failed, with all temporarily closing at one point, and mortgage lending had dropped 80 percent to $663 million between 1930 and 1933, the report, published by the American Enterprise Institute for Public Policy Research, stated.

The average borrower refinanced by the program was two years delinquent on the loan. Based on the property’s value, the lender would often take a loss on the principal of the original mortgage, receiving less than the mortgage’s par value in bonds. But this provided the lender with “an earning marketable bond — although with a lower interest rate than the original mortgage — in place of a frozen, nonearning asset,” the report’s author, Alex J. Pollock, wrote.

“‘The willingness of lenders to compromise,’ was an essential element of the reliquification program — just as it will be in our current mortgage bust,” the author added.

During its 18-year in operation, ending in 1951, the corporation bought over 1 million loans or 20 percent of all mortgages outstanding at the time. At its peak, it employed over 20,000 people. It ended with a surplus of $14 million, which is considered successful when taking into account that it was feared the venture could result in up to $500 million in losses for the government, Pollock wrote.

Dodd also requested that the stimulus package include the Federal Housing Administration Modernization Act, a temporary raise in conforming loan limits, and $10 billion for the Community Development Block Grant to allow local governments to buy foreclosed homes, and rehabilitate and resell them.

Related:

Foreclosure Solutions or Problems?
A national legal network has announced plans to help delinquent borrowers avoid foreclosure by exploiting mistakes made by mortgage companies. Meanwhile, a recent report is calling for the return of an innovative Depression era program to refinance borrowers facing foreclosure, and one of the Federal Home Loan Banks is funding a program with below market interest mortgage rates.