Thursday, December 6, 2007

What's the Deal with the Subprime Interest Rate Freeze?

This afternoon, President Bush and Treasury Secretary Henry Paulson announced an agreement among home mortgage investors to absorb some of the blow about to befall homeowners as their subprime mortgage interest rates reset. This isn't the government bailout of which Jeff laments. Nobody doubts that's coming. The plan announced today is a political maneuver in an election season by the White House to appear to be doing something to help American people in crisis. Paulson was guarded in his estimation of the impact of the plan on consumers. "[T]his plan is not a silver bullet, you're not going to be able to solve every conceivable issue. What five years does is it gives people, it gives us as a country, a chance to work through this housing cycle." A five year freeze gives the set of borrowers who qualify for it time to boost their credit scores, and build their income to qualify for a conventional prime home loan. What if five years isn't enough time? Paulson said,"Under the worst condition, you're going to go through a refinancing program five years from now but we'll have five years to deal with it." The unspoken subtext: "And this problem will be on the desk of another president." FDIC Chair Sheila Blair, in a press conference of her own this afternoon, spun loud and clear: "I applaud Secretary Paulson's vision in recognizing that we are in a virtually unprecedented credit environment and that difficult choices have to be made."

That said, the plan is no small accomplishment. Paulson, with the political muscle of the White House, appears to have brokered a deal among investors who hold subprime mortgage portfolios to freeze home mortgage rates for an estimated 1.2 million homeowners . Paulson said at a press conference today: "I saw a role for government here -- to convene market participants with common interest to determine if, and then how, they could develop a shared framework to address both the market complexity and the upcoming value of mortgage resets." (Reuters coverage here.).

The story I have yet to see reported is how this deal was made. We can infer a little from the terms. Key mortgage investors agreed (with no remedy for breach) to freeze in place the starter or "teaser" interest rate on some home mortgages. The agreed freeze only affects borrowers who are current on payments and who can make monthly payments under the teaser rate. Borrowers who are currently or previously in default get no freeze. And, borrowers who don't have the financial ability to make payments at the teaser rate get no benefit under the plan. Moreover, there's no freeze for borrowers financially capable of paying the higher reset rate. Regardless of the borrower's payment or financial status, the plan covers only mortgages with adjustable rates that will reset beginning in 2008. Borrowers with mortgages that have already reset together with those who are in default or otherwise can't make the teaser rate payment on their loans remain at square one. They will have to "work with" their mortgage servicers on an individual basis to save their homes from foreclosure.

It appears that mortgage investors agreed that taking a little pain voluntarily would build their public image as responsible citizens, perhaps enough to garner the support they'll need in upcoming months to escape open heart surgery without anethsthesia at the hands of Congress. Perhaps the driver for investors' acceptance of the plan is fear of litigation over modification of loans for which the lender is not easily identifiable after layers of securitization. An agreement among investors to freeze rates on a set of loans across the board could blunt expensive inter-investor litigation.

The effect on investors of the plan is nothing, nothing at all, compared to what the Democratic presidential front runner has in mind for them. Yesterday, news of Paulson's plan leaked as Hillary Clinton was presenting her own plan for resolving the subprime mortgage crisis during a speech in NYC and later in an interview on CNBC. (see video here.). Clinton proposed a $5 million gift from the government care of US taxpayers to help communities cope with foreclosures. She pointed a menacing finger of blame in the direction of "corporate America." "Wall Street helped create the foreclosure crisis, and Wall Street needs to help solve it." (coverage of Clinton's speech here).

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