Good politics, but terrible economics
The expected backlash to the plan started immediately after President Bush, along with Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson, outlined proposals Thursday that are meant to help the 2 million borrowers facing sharply rising rates on their adjustable-rate mortgages beginning next month. Housing advocates said it leaves millions of struggling borrowers at risk of foreclosure. Others decried it as a shameful bailout of irresponsible lenders and borrowers.
"President Bush's plan may make good politics, but it is terrible economics," said Edward Ketz, an accounting professor at Penn State University. "It punishes those who have acted prudently and rewards bad decisions by homeowners who bought what they could not afford. It gives incentives for future homebuyers to act rashly, because they may believe Washington will rescue them from error and greed."
"Politicians want to look like they are doing something while not doing something," says Joseph Mason, a professor at Drexel University who studies banking regulation and capital markets. "This plan fits that perfectly."
What it also does is pass the problem on to the next president, who will be elected next fall, well before the freeze on those mortgages lifts--and possibly before the markets turn around. Despite a strong showing in many financial stocks Thursday after the plan was announced, analysts forecast slower growth for banks as they come to terms with rising credit costs and a slowdown in their bond divisions.
Here is Hillary Clinton's take on the Bush plan:
"The Bush plan is designed to help as few homeowners as possible. ... America needs a plan that matches the scale of the crisis, and President Bush has failed to deliver it. ... My plan imposes an immediate moratorium on foreclosures; an automatic, across-the-board rate freeze; and the requirement that servicers and lenders provide status reports on how many mortgages they are converting from designed-to-fail to designed-to-work. ... But if the mortgage industry and Wall Street will not shoulder their responsibility, then I will consider legislation to protect servicers and others who do the right thing by modifying loans to help families save their homes, help investors avoid losses, and help the economy."
Even President Bush acknowledged the plan to freeze the interest rate on subprime mortgages is "no perfect solution." Treasury Secretary Henry Paulson said it was not a "silver bullet."
Bush's plan may be shaking confidence in the bond market while actually doing little to help borrowers.
Mortgage servicers either originate their own loans or buy loan-servicing rights to them. The loans are sold to banks, which then chop them up and repackage them in securities, complete with ratings and tranches to appeal to different types of investors. These investors buy the securities expecting certain performance characteristics, including payment flows from the borrowers of the underlying loans.
If an investor can't count on the terms of a mortgage security at the time he buys it, he has less incentive to continue investing in them in the future. That would reduce demand for mortgage paper, in addition to embedding a risk premium in the rate for those investors still willing to take the gamble.
According to Standard & Poor's freezing rates on subprime mortgage loans may lead to credit-rating reductions on some mortgage bonds. The government's plan may shrink the difference between interest payments received from home loans and the interest due to bondholders, S&P said in a report.
Analysts agree that the Bush plan which is advertised to rescue the housing market and keep the economy from slipping into recession by freezing interest rate hikes for a mere fraction of subprime, adjustable-rate borrowers could deepen and lengthen the credit crisis.
Analysts also warn that the plan could further choke off the credit markets and result in higher mortgage rates in the long run.
Under the plan 1.2 million homeowners relatively current on their mortgages would contact credit counselors (1-888-995-HOPE) or their loan-servicing companies that would sort them by their credit and payment history and ability to pay. Those 60 days behind on more than one mortgage payment over the past year would get credit counseling to talk them through the loss of their homes.
600,000 of these are expected to receive credit counseling followed by a refinance that would lock in their teaser rates. These lucky ones who can't afford the higher payments, and who have credit scores below 660 and less than 3% equity in their homes, will get the biggest break from the lenders. They receive a five-year extension on their introductory interest rates, with the possibility that the grace period will be extended.
Homeowners dialing up their mortgage company to get their current rate frozen could be disappointed. The White House plan does not force mortgage companies to give eligible homeowners a break. It is voluntary.
According to analysis by Barclays Capital, the "freezer-teaser" plan applies to just 240,000 subprime loans. The Mortgage Bankers Association reports the number of subprime adjustable rate mortgages at 2.9 million.
Only those who took out subprime loans between 2005 and July 2007, live in those homes and have credit scores below 660 will be able to obtain a rate freeze with little hassle.
The ranks of those who fell into foreclosure in the third quarter hit a record high of 351,000, according to the Mortgage Bankers Association survey released on Thursday. And 5.6% of all loans are behind on their mortgage payments, the highest level since 1986.
About 600,000 homeowners with credit scores above 660 and more equity will be deemed able to afford to pay when their existing loans adjust upward starting in January. They would receive no special assistance. A middle group, who may or may not struggle with the increased interest rates, will have to negotiate individually with their loan-servicing companies to secure a rate freeze, repayment holiday or other relief. It also won't help the 16% of subprime borrowers who are already delinquent or in default, or who have the unhappy circumstance of having a house worth less than their mortgage or a loan that has already reset to the higher rates.The freeze applies only to loans taken between January 2005 and July 2007.