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Subprime relief: Winners and losersBy Holden Lewis A consortium of lenders is considering a plan to reduce foreclosures by freezing low introductory interest rates on subprime mortgages. There would be winners and losers under such a policy. The winners would include those borrowers who qualify for rate relief, their neighbors, and state and local governments. The losers mainly would consist of people who want to buy bargain houses within the next few years. The policy is bound to annoy homeowners who didn't overextend themselves, and who perceive rate relief as a bailout for irresponsible borrowers and lenders who drove up home prices for everyone else. According to a Wall Street Journal article, the Bush administration and some big mortgage lenders -- Countrywide, Citigroup, Washington Mutual and Wells Fargo -- are cooking up a plan to keep the introductory interest rates on certain subprime mortgages unchanged. Most subprime mortgages are called 2/28 ARMs because they have an introductory rate that lasts two years and then the rate can be adjusted up or down every six or 12 months in each of the 28 years after that. A typical 2/28 mortgage underwritten in early 2006 had a starting rate of around 8.25 percent. When the loans are reset at their two-year anniversary, many of these borrowers can expect the rates to climb to 10 percent or higher. On a $200,000 loan, the monthly principal and interest payment would rise $289 (to $1,792) if the rate jumped from 8.25 percent to 10.25 percent after two years. People get subprime loans because they have credit problems, and a sudden monthly increase of that magnitude can tip their family finances over the edge and send borrowers into foreclosure. Faced with the reality of rising foreclosures, and the prospect of the problem getting worse, the big lenders and federal regulators have accepted a suggestion made early this year by Sheila Bair, chairman of the Federal Deposit Insurance Corp. Bair proposed that lenders freeze introductory rates for borrowers who could afford to make those payments, but couldn't afford higher payments after reset. More than 1.5 million of these subprime loans, worth $330 billion, are scheduled to undergo their first rate reset between September 2007 and the end of 2008, FDIC official Michael Krimminger told the House Financial Services Committee Friday, Nov. 30. Most are current, Krimminger said -- but at least 1.1 million "may not remain so after reset." It makes sense, he added, for lenders to "take a systematic and streamlined approach to restructuring these loans into fixed-rate loans at the starter rate." For one thing, it's faster and cheaper to do it that way than to scrutinize each loan case by case. If big lenders and regulators adopt the policy, here is a possible list of winners and losers. Winners The main winners would be the borrowers who keep their houses instead of losing them in foreclosure. Their neighbors would benefit because they wouldn't have to live near empty, foreclosed houses. Local and state governments would continue to collect property taxes in many cases. "One doesn't like to renegotiate legal agreements made in good faith," says Jared Bernstein, director of the living standards program for the Economic Policy Institute, a Washington think tank. "But these are very unusual times. Basically, there are a lot of people who shouldn't be losing their homes, who probably would if we didn't take action otherwise." There's a value judgment lurking in Bernstein's use of the word "shouldn't" -- that borrowers "shouldn't be losing their homes." One might just as easily use the same word to say that these borrowers shouldn't have gotten subprime loans that they couldn't afford after rate reset. But it's not as simple as that, Bernstein says. People made mistakes and passed off the risk all along the lengthy chain, from the borrowers to the holders of mortgage-backed securities. "There were a lot of market failures that went on here, and when the market fails, the government should step in and take some action," Bernstein says. He echoes an argument made by the FDIC official that the policy helps lenders and mortgage investors, too. "If these homes end up on a market that's awash in inventory, they're not going anywhere anyway," Bernstein says. "If you foreclose on one of these homes, you have an asset that's depreciating quickly." In this case, one person's calamity can be another person's bargain. That brings us to the losers under this plan. Losers Clearly house prices in many markets will fall over the coming months and years. The question is how far values will fall, and how long it will take. If subprime resets add to the wave of foreclosures next year, there will be more vacant houses for sale in some markets, and prices will plunge. When they have fallen far enough, buyers will flood into the market and prices will rise. If the big lenders and federal government adopt the plan to freeze subprime ARMs' introductory rates, there will be fewer foreclosures. Prices won't fall as rapidly. Buyers might be more reluctant to buy, and a recovery in prices could be delayed. That scenario is possible, says Michael Moskowitz, president of Equity Now, a mortgage lender in New York City. He acknowledges that it would be bad news for first-time buyers and bargain hunters. "But we're in this, and it's getting worse, and I'm sort of afraid to let the movie play out to the end without changing the script," he says. Moskowitz says he feels torn. He favors the least possible government intervention in the marketplace, but it seems warranted this time. "Up until several weeks ago, I was going, 'People made their own beds. Let them sleep in them.' But you can't punish everybody for the excesses of the speculators." In the next breath, Moskowitz worries about unintended consequences: "I'm sort of torn. Many of these buyers knew exactly what they were doing." Lenders have to watch out for borrowers who gamed the system once and who will try to do it again. Then there are homeowners who followed the conservative route of saving up for a down payment, buying a house within their means and getting a fixed-rate mortgage. To them, the rate-freeze proposal makes a mockery of responsible behavior. "You're rewarding what I think is irresponsible," says Renee Wajda, an engineer who owns a home near Philadelphia. "And in a way you are also rewarding the industry, because you're insulating them from foreclosures." She says she feels ambivalent about the proposal. "If I had a neighbor going through this, I guess I would like it, from a selfish standpoint," Wajda says. "From a moral standpoint I don't think it's a good idea. I just think that it rewards people for going out on a limb. The whole thing with an ARM is that risk is involved. When you get rates at rock bottom, there's generally only one direction that rates will go." That would be up. -- Posted: Dec. 3, 2007 |
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