Bush Administration Subprime Mortgage Freeze — A Virtual Symposium

Treasury Secretary Henry Paulson’s idea for rescuing subprime borrowers from foreclosure was announced in a speech today:

The freeze would apply to adjustable-rate mortgages originated between Jan. 1, 2005, and July 31, 2007, which would reset between Jan. 1, 2008, and July 31, 2010. The program is designed to help those with two-year or three-year low teaser rates on their mortgages.

It would only affect borrowers living in their homes, not those who purchased housing for investment purposes. According to the source briefed on the plan, those who have a 3 percent equity stake or more in their property also would not be eligible for the freeze.

Under the reasoning of federal officials, those who currently have financial wherewithal to make their payments but would struggle to pay a higher reset rate could qualify for refinancing.

The Bush administration is expected to seek authority to enable state and local governments to use tax-exempt bonds to fund these refinancings, an idea floated by Treasury Secretary Henry Paulson in a speech on Monday.

So what did everybody think?

The National Association of Home Builders was pleased, but wants more help, such as “FHA reform legislation to allow the agency to insure more home loans and help subprime borrowers,” and more “regulatory oversight of Fannie Mae and Freddie Mac and allow them to purchase mortgages in high-cost markets.”

The Neighborhood Assistance Corporation of America (NACA) , an affordable-housing advocacy group, saw the Bush/Paulson plan as the Administration’s first step to “limit damage by big business” and set “a new standard for government intervention in the mortgage industry.” It’s not enough, however. From NACA’s press release:

The mortgage industry has pushed defective mortgage products that created this crisis. These mortgages were never about long-term homeownership, but about massive profits for the lenders, investment bankers, brokers and rating agencies. NACA has been in the forefront of combating the mortgage crisis and has provided the most significant solution with its agreement with Countrywide Financial that permanently reduces the interest rate for homeowners to what they can afford – often to five or six percent fixed.

The Bush administration’s rescue plan impacts a limited number of homeowners and even those within the criteria will only have a temporary reprieve. Freezing interest rates temporarily is analogous to having a defective automobile with no brakes, and rather than fix the brakes, you are allowed to park it while making the payments and then drive it down the hill full speed. The inevitable result will be a crash or in mortgage terms – foreclosure.

In his blog The Big Picture, market strategist Barry Ritholtz points to the scope of the problem — a projected 775,000 homes with $143 billion in subprime mortgage debt projected to go into foreclosure — and says of the Bush Administration:

Hence, the political and economic motivation for doing something — anything — rather than look like they are just sitting there.

Ritholtz’s opposition to the plan is over what it left out:

This plan does nothing to address the issues which led to the snafu in the first place:

• The FOMC (Federal Open Market Committee), who took rates down to historic lows, and left them there for a year;

• Ratings agencies, (not unlike the equity scandal of the 1990s) were in cahoots with underwriters, to the detriment of investors;

• The Federal Reserve, in their capacity of over-seers of the Banking industry, failed to supervise the rampant issuance of irresponsible debt

Peter Cohan at Blogging Stocks sees only the direct beneficiaries of the Bush program as gaining anything. Their gains come at the expense of mortgage-backed securities owners, all the other mortgage holders who don’t qualify, as well as two intangibles:

  • Free markets. W’s plan thumbs its nose at the notion of free markets. It allows the free markets to work for borrowers not covered by the plan, while replacing free markets with government intervention for those borrowers who happen to have lucked into being in the class of people the plan covers. And if the plan was intended to limit the number of foreclosures, it’s not clear that it will succeed at that. That’s because the people who have not been able to make their teaser payments are more likely to foreclose. While the ones being helped by the plan — those who are making their payments — would have been more likely to afford to pay the higher reset amount in their original mortgage contracts.
  • George W. Bush’s legacy. Given the damage W’s plan is likely to cause for these “losers,” George W. Bush’s legacy is also likely to take a hit. Fortunately for him, in the absence of more details. it is difficult to know whether his plan will actually go into effect or if — like his SIV rescue plan — it will stall. One thing seems clear, whichever group is left out of the plan — and this appears to include MBS investors — will resist its implementation.

Economist Ryan Avent is starts off snarky, then makes a serious point. One good way to avoid default is to sell your house, and that’s getting harder:

As someone who bought a home in 2005 with a prime, fixed-rate mortgage, I’m kind of wishing I’d gone for the unconventional loan product and gotten myself a lot more house.

My general thought right now, however, is that we’d be much better off following Larry Summers’ advice and ensuring that there’s a ready supply of mortgage credit to qualifying borrowers. I suspect a big problem with the housing market currently is that people who’d like to and are able to buy are having difficulty getting a mortgage. Absence of liquidity in the housing markets is going to force prices down farther than they need to go, and it makes it difficult for struggling homeowners to get out of their mortgages by selling their properties.

A half-dozen economists are quoted in the Wall Street Journal’s Real Time Economics blog, including Peter D. Schiff’s view that

Without question, the Bush administration’s mortgage rescue plan will exacerbate, not alleviate, the problems in the housing market. As the plan will sharply reduce the ability of new buyers to make purchases, it really amounts to a stay of execution and not a pardon.

BusinessWeek’s Peter Coy is also scathing, citing the unfairness to borrowers who paid a premium to avoid ARMs and now are seeing the teaser rates that didn’t draw them in extended.

A Resolution Trust Corp.-style bailout might have been a cleaner way of dealing with this mess. Makes me wonder whether in its zeal to come up with a solution that could be labeled 100% “private sector” for political consumption, the Bush Administration made some poor choices.

In another WSJ blog, Deal Journal, Dennis K. Berman has an even more ominous take, comparing the new Administration policies to the kind of policies that sank the Japanese economy in the 1990s:

For decades, Japan pursued a “convoy system” for its banking regulation, forcing some of its larger and healthier banks to absorb some of the bad loans of weaker brethren. The approach worked fine for a long time, until the convoy –overloaded with years of mispriced debts — ground Japan’s economy to a terrible halt…

(Paulson’s) mortgage approach is similar, as it plans to freeze the worst economic outcomes (potential foreclosures) so the system will have more time to come up with less bad outcomes (less-costly workouts).

The discussion continues. Please add your thoughts in the comments.

My expertise doesn’t stack up with that of the people I cite, but I’ll offer an opinion anyway.

I think we’re crossing into a new period of economic history. After more than 25 years of booming economic momentum, signs of age are beginning to show. Apparently, a lot of us have been living beyond our means, a fact that will come much clearer as more baby boomers face retirement with depleted savings accounts, bankrupt pension programs, and overstressed Social Security.

So far, it’s not clear whether the Masters of the Universe on Wall Street and in Washington are up to the challenge. In 2007–perhaps a turning point–leadership seems to be lacking in basic insight into what’s going on. Too many people who shouldn’t be surprised are telling us they’re surprised. It can make a person uneasy.

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2 Comments on “Bush Administration Subprime Mortgage Freeze — A Virtual Symposium”

  1. Pat Says:

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