Last week’s White House plan to freeze some adjustable mortgages to slow the rising pace of foreclosures seem to raise as many reader questions as it answered. There’s a lot of confusion about just who is covered and who isn’t. And many readers are wondering: Just what’s all this going to cost?
What does President Bush's plan to freeze interest rates on (adjustable rate mortgages) mean for those of us consumers that have conventional mortgages with fixed rates?
— Alan H. Brainerd, Minn.
Homeowners with conventional fixed rate mortgages would not be affected directly by the plan announced last week.
And only a portion of the two million or so homeowners with adjustable rate mortgages that are scheduled to jump to higher payments would eligible for the freeze. If you’ve already fallen behind in your payments or are in foreclosure, you’re not eligible. If you have a relatively good credit history, and the government decides you can afford the higher rate, you don’t get a freeze. You have to live the home purchased with the mortgage. And the freeze would only apply to those who took out an adjustable between Jan. 1, 2005 and July 31, 2007, and who face an interest rate reset sometime between Jan. 1, 2008 and July 31, 2010.
The Treasury has set up a hotline — 1-888-995-HOPE — for people who think they may be eligible. They’ll be asked to provide information about their loan and personal finances.
Estimates vary, but it looks like the plan could end up helping just a few hundred thousand homeowners. No one can say for sure until the process gets underway. And the system is voluntary — some lenders have signed on to participate, others haven’t. Even if they participate, the lender has to review each loan and make a decision on a case-by-case basis.
Those decisions have already been underway by loan “servicers” — the people who collect payments and manage mortgages on behalf of the investors who own them. One way the President's plan will help speed up the process of fixing these bad loans is by helping to give the servicers the legal cover to freeze rates. The problem is that if the loan rate is frozen, the investor who bought the mortgage gets a lower return.
It’s not a lot different than you putting your savings in a bank Certificate of Deposit based on a promise to get, say, 5 percent interest. If the bank later came back and said: “Sorry, we’re having trouble paying the interest, we’re going to lower the rate to 4 percent.” It wouldn’t be hard to find an attorney who would help you sue the bank and get full payment. One of the basic tenets of contract law is: “A deal’s a deal.”
The White House plan is really a way of extending informal legal protection to servicers who want to freeze rates without actually doing so. If you’re a servicer, and you make a judgment to modify a loan because you think the increased in monthly payments will force the homeowner to default, you have the burden of proving that the default was inevitable. That’s really hard to do. Maybe the homeowner would have just tightened their belts and paid the higher rate. So if you’re a servicer — why stick your neck out?
If the government develops a standard analysis and guidelines for determining who is likely to default, the servicers can turn around and say: “We acted in good faith based on guidelines developed by the U.S. Treasury.” It’s not as good as the Treasury saying to the servicers: “We will indemnify you if you get sued.” Or saying to the investors: “We’ll make you whole if the loan is frozen.” That would cost taxpayer money.
So now we wait and see if the servicers buy it. If they can get a blanket approval up front from large investors that these guidelines are acceptable, they can proceed with some confidence they won’t end up in court.
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It’s also not clear how the “temporary” freeze will work. Does the borrower still face a reset later? Is the hope that during the freeze, the mortgage and housing markets recover and conventional refinancing channels open up — after steep prepayment penalties have expired?
There a still lots of questions as to how this will play out. Congress is looking at changing the bankruptcy law to allow judges to decide, in effect, to freeze a particular loan if the borrower goes to bankruptcy court. If the Bush plan doesn’t work, the political pressure to make such a change could grow stronger.
And with the resets scheduled to continue for the next several years, there may be other solutions on the horizon. One idea would be for the government to buy up these loans — many of which are currently selling in the credit markets at big discount — and work out terms directly with borrowers. If the housing and mortgage markets recover and homeowners keep their homes and make payments on time, the market value of these loans could actually increase. And the government might even make money on the deal.
Apparently I’m not the only one reluctant to have the government step in and subsidize borrower’s stupidity or negligence. Has anyone attempted to quantify the cost of a government bailout?
— Marc B., Charlotte, N.C.
At this point, the cost of cleaning up the mortgage mess is really unknowable.
The White House plan to freeze rates would mean investors who bought the bonds backed by these mortgage would have to accept less money. But many of these bonds have already lost value because no one wants them at the original price — which was based on the flawed premise that people who were sold mortgages they couldn't afford would somehow figure out how to pay them off. Bonds that carry the greatest risk — those in the mortgage pools that get paid last if any mortgages default — are trading for as little as 20 cents on the dollar. So some investors figure something is better than nothing.
Under the Bush plan, no taxpayer dollars are being paid directly to borrowers or investors, so in that sense the plan is not a “bailout.” But both sides get something out of the deal. Homeowners get a break on mortgage payments they committed to and investors increase the chance that the loans they own won’t default.
A lot of adjustable mortgages won’t be covered in the Bush plan. If those homeowner can’t keep up, the cost of foreclosures will rise, investors will see more losses from defaults, houses will be put back on the market and hurt everyone's house price, and communities with high foreclosure rates will deteriorate.
So the rise in foreclosures is going to be expensive one way or another. Last month, Fed Chairman Ben Bernanke told the Joint Economic Committee of Congress that he thought $150 billion — about what it cost to clean up the savings and loan industry mess in the late 1980s — was “in the ballpark.”
That’s his estimate not mine. It could be more.
One point to remember: We all drink from the same financial well. You can’t have 2 million more people lose their homes and not expect a serious recession along with it. If that happens, more people lose their jobs and their income. They then have less money to spend, which hurts other businesses. And there are fewer people who can afford a home, so weak demand prolongs the housing recession.
One way or the other, the housing and lending bust is going to cost you. If the government can step in an minimize the damage, we’re all better off in the long run.
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