Wednesday, December 12, 2007

The Bush-Paulson Plan to Freeze Rates: It's Only a Start

by Nancy Osborne, COO of ERATE


As usual the government is behind the curve on this one. It would have been far better to dissuade Wall Street from exploiting the misguided lending practices that got us into this mess is the first place however at least the now proposed plan is an attempt to bail out the poor homeowner and not the corporations. Wall Street made billions off of sub-prime debt and rather than questioning the sanity of what was happening they were generating so much money in the way of service fees that they were able to rationalize all the obvious risk away. The banking and financial industry felt compelled to sign off on the Bush-Paulson plan for fear of what congress would come up with if they did not. Up until now Treasury Secretary Paulson had maintained that the sub-prime crisis should be dealt with on a case-by-case basis, a position which would have tended to support a bill currently in the U.S. Senate granting bankruptcy judges the right to change the terms of a mortgage loan if a judge deemed it necessary in the course of a Chapter 13 proceeding. The authority extended to the bankruptcy judges under the proposed bill is to be permitted without any input from either the lenders or investors involved. The banks have already received some corporate relief as Paulson has put together a toxic debt superfund of some $100 billion to purchase the garbage short-term debt of the so-called structured investment vehicles (SIVs) which the banks themselves had set up to keep their poor quality mortgage-backed securities in off balance sheet entities (Enron deja vu).

Who is the plan going to help?

The government's goal is to help those borrowers who have been able to make their mortgage payments up until now but will struggle once their interest rate is re-set. The plan would effectively freeze these borrower's rates for a five year period. Targeted borrowers are those who obtained owner-occupied adjustable rate mortgages from January 1, 2005 to July 30, 2007 which are due to re-set between the period of January 1, 2008 and July 31, 2010. Borrowers with credit scores below 660 will receive much initial attention under the plan as these homeowners are the most likely to have been given adjustable loans with low teaser rates which are due to spike up to 7% to 9% in the coming months. These rate increases could translate into a hike in the monthly payment of those affected by as much as 30% in some cases.

Are there any additional requirements of the borrowers targeted under the plan in order to qualify for the relief?

All mortgage payments under the initial teaser or start rate must be current and paid up to the previous two months and borrowers must have provided income documentation to qualify for the loan. Additionally only those borrowers having less than 3% equity in their home will be eligible under the program. And as stated above, only those who are owner occupants of the affected properties will be eligible.

Why are only the borrowers within that specific 2.5 year time frame being targeted for relief under the plan?

Because it is those borrowers who purchased their homes at the tail end of the real estate boom who are likely to lose or have already lost equity in their homes and in some cases may now be upside down on their loans (essentially their home is worth less than the mortgage balance on it). These borrowers will have the most difficult time refinancing even if rates were to come down because they lack both equity and decent credit in this new lending climate. Foreclosure may be most likely for these homeowners because they stand nothing to lose by simply walking away from their home as they have little or no equity stake in it.

Why does the government feel it necessary to get involved at this point?

Because over two million sub-prime borrowers have loans on tap to re-set to substantially higher rates over the next two years. Housing prices are already declining in many areas and if foreclosures were to accelerate it is believed that every 70,000 foreclosures could translate into a 1% drop in home values. The hope is that the plan will forestall severe and on-going damage to the housing market nationwide which could potentially throw the country into an unprecedented recession as housing has become the linchpin of the economy and the underlying engine of both consumer confidence and spending.

What are some of the obstacles to the plan?

First and foremost the plan is a voluntary one, it does not require mortgage lenders to comply. The plan will stop the bleeding for the targeted borrowers but at whose cost and are those who are going to incur the loss going to take in lying down? The finger pointing has already begun and the potential lawsuits should have attorneys working overtime. As part of the plan a so-called "safe harbor" preventing lawsuits has been proposed but we will see if it is viable as it will likely be tested. Also of significance is what impact the governments interference in a private contract matter (from the standpoint of the investor) will have on the securitization of debt in the future as well as the over all confidence of investors, both domestic and foreign, in the integrity of the U.S. financial markets as it appears that supposedly binding legal contracts can be altered. Seems like a classic catch-22 situation for all involved.

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