This story about FHFA trying to boost short sales was sent my way:

The regulator for Fannie Mae and Freddie Mac on Tuesday announced a new policy that aims to speed up the process mortgage servicers apply when dealing with distressed loans backed by the two U.S. government-run companies.

The Federal Housing Finance Agency said it has directed both Fannie Mae and Freddie Mac to develop “enhanced and aligned strategies” for securing a so-called short sale, in which the servicer or bank accepts less than the balance owed on a property, the regulator said in a statement [...]

The new timeline will require servicers, who collect borrowers’ mortgage payments, to respond to a request for a short sale within 30 days and to make a final decision on the property at the end of 60 days.

This doesn’t say anything about the servicer having to approve a short sale. Mortgage industry observers tell me that short sales often get nixed by servicers for inscrutable reasons. The outcome for homeowners if a short sale gets rejected is pretty bleak. However, short sales have been increasing over the last six months or so. And this move by FHFA would at least get clarity for the borrower quickly.

However, all of this runs into a brick wall if the Mortgage Forgiveness Debt Relief Act expires on schedule. I’ve written about this before, but it’s so crucial that it deserves to be brought up again and again, especially in the context of short sales and mortgage relief generally.

The law, first enacted in 2007, allows homeowners who have received principal reductions on their mortgages as the result of loan modifications, short sales or foreclosures to avoid income taxation on the amounts forgiven.

Loss of that tax help would endanger huge numbers of distressed mortgage arrangements in the months ahead. For example, the $25 billion mortgage settlement with 50 state attorneys general requires the banks to provide more than $10 billion in principal reductions to borrowers. Meanwhile, other lenders and mortgage servicers who are not parties to the settlement already provide principal reductions to troubled borrowers. Many of these owners would face hefty and ill-timed taxable income hits in the event the law is not extended.

Yet election-year politics and a contentious lame-duck, year-end congressional session loaded down with tax and budget issues could doom renewal of the debt-relief tax legislation and put large numbers of loan-modification participants deeply in the hole.

Say you get a $50,000 principal reduction as part of the settlement. Without an extension of the Mortgage Forgiveness Debt Relief Act, you would have a tax bill in 2013 of as much as 35% on that $50,000 in “income.” It will probably put you in a higher tax bracket. And because of the fact that, if you had that kind of money to throw around, you wouldn’t be a struggling borrower in the first place, you’re in no position to pay that tax bill. Even the insulting $2,000 given under the settlement to those foreclosed upon would get taxes, if the Mortgage Forgiveness Debt Relief Act expires. And the same goes for a short sale; the difference between the sale price of the house and the “true value” would be considered income, and taxed accordingly.

This is a total nightmare scenario for homeowners, the final indignity of the whole mortgage crisis. Homeowners were ripped off in origination, had their chain of title broken in securitization, faced a foreclosure with faulty documents, and then, when they get a principal reduction as part of a piddling settlement on these issues, Uncle Sam forces them to “pay” for the privilege of the write-down.

There’s legislation pending in the House to extend this law, but I have no faith it will get taken up. Because expiration happens in the lame duck session, and because lawmakers have smartly raised the profile of big tax levies on “servicemembers” (because we all know how lawmakers jump at the mere mention of the military), maybe there’s an outside chance of this getting folded into whatever deal takes place at the end of the year. But I’m not holding my breath, and housing advocates need to seriously raise the profile of this.