5 Holes in the Government's Mortgage Bailout Plan

It appears that the plan first announced by the Government last week to bail out holders of ARM mortgages is near finalization; Bush is expected to announce terms of the plan today (12/6/07). As anticipated, the plan will freeze mortgages for about five years, while the borrower attempts to get their finances strong enough to refinance. Additionally, the plan will be limited in scope to borrowers with less than 3% equity and who are 60 days or less behind on their mortgages.

(From the Financial Times) “The five-year freeze – a compromise between regulators, who were pushing for a seven-year freeze, and some lenders, who had argued for a one- or two-year freeze – was in a draft accord circulated on Wednesday, a Treasury official confirmed...
… But the official cautioned that as of Wednesday night, the agreement had still not been approved by all parties involved. It was also unclear whether investors in securities backed by mortgages might object.
Under the plan, mortgage servicers would agree to the five-year rate freeze voluntarily. An industry lobbyist said the freeze would apply to subprime adjustable rate loans taken out between January 2005 and July 2007, with rates scheduled to step up between January 2008 and July 2010.
It would apply only to borrowers who had less than 3 per cent equity in their homes and were either current on their payments or no more than 60 days delinquent. The borrower would have to demonstrate that he or she was unable to afford the increased rate…
… He said servicers would identify borrowers eligible for refinancing based on simple criteria – such as credit score, size of loan and loan-to-value ratio – and fast track them into new loans offered by the Federal Housing Association and private lenders.
Borrowers who are not eligible for refinancing could qualify for the five-year rate freeze, a process called loan modification.
The plan can proceed without legislation. But the administration needs the support of Congress to raise the limit on the size of loans that can be offered by the FHA as part of the refinancing plan.
“I think it’s going to help the industry streamline the process by which we keep homeowners in their homes and should increase the number of modifications we do,” said Kurt Pfotenhauer of the Mortgage Bankers Association.”

My thoughts on this plan (as initially proposed) are already well known, so let’s just quickly address some of the specifics in the finalized version:

1. The plan focuses on a narrow subset of borrowers and is unlikely to fully address the problem of rapidly accelerating foreclosures. The plan ignores many home owners that are already in trouble, as there are plenty of people with more than 3% equity that will be in trouble once their rate resets, and no documentation loans are probably a bigger problem than ARMs. Not to mention the fact that many holders of prime mortgages are in trouble as well.
2. If someone is 60 days past due on their mortgage (around the holidays no less), freezing their interest rate isn’t going to help them get back on track, especially if the rate hasn’t reset yet. The mortgage crisis is a function of affordability, so freezing interest rates won’t help people pay the mortgages on homes they can’t afford. In fact, including the “60 days in arrears” group is almost laughable as this program does nothing to help them.
3. The moral hazard is huge as we’re rewarding the people who bought homes they couldn’t afford with risky mortgages and shaky finances, while punishing those who made smart home buying decisions, who may wind up paying for the plan one way or another. Furthermore, the plan encourages the bad behavior (on the part of lenders and borrowers) that created the credit bubble in the first place.
4. I fail to see how the program streamlines the process of lenders helping borrowers who are on shaky ground, since the lenders who own loan modification programs have been largely useless.
5. The program is only delaying the inevitable. If you’re in a home you can’t afford and/or are currently unable to refinance, chances are you’ll need a sharp increase in income, a reduction in principle or a reduction in your interest rate to keep your home long-term. Delaying the “ARM day of reckoning” by five years is unlikely to make a difference for most home owners.

In the end, this plan makes for good headlines and may very well make the general public feel as if the government is doing something to address the mortgage crisis. However, that doesn’t change the fact that the plan will be of limited efficacy and is out of touch with the reality behind the mortgage crisis. Finally, the moral hazard introduced by the plan is simply too great, why would any sane person encourage the very behavior that caused a global credit crisis?!

Sources:

The Financial Times: “Bush to unveil mortgage plan” -- Krishna Guha and Stephanie Kirchgaessner, December 5, 2007

Comments

[User 128189:]

The "Plan" is not about refinancing anything, it is about time. In five years Social Security and Medicare payments will consume 4/5ths of the United States revenue. The other 5th will go to pay intrest on the debt. So, the 5 years is just about putting off the end as long as they can.

2007 Dec 06 12:21 PM

[Dominick:]

This plan looks ineffective – it just delays the housing correction so that some of its problems will be put off until after the elections.

Also, good regarding Social Security for baby boomers. This will be the next drag on the economy.

2007 Dec 06 03:18 PM

[goforth:]

Which is the better choice, let market forces prevail and flood the country with millions of bank owned foreclosures, further dragging down the price of residential realestate and pushing the already stressed economy into recession, or freeze the status quo allowing the excess to be gradually absorbed overtime into the realestate market. My paid for home in southern California has already lost 20% of it's peak value. If defaults continue unabated I foresee losing at least 50% or more as forclosures flood the market, and the banks wholesale their unwanted inventory. Do the math. The stock market has already expressed it's approval. Please don't be blinded by the abject failures of the Bush administration that brought us to this point, and consider the best way to salvage what we can.

2007 Dec 06 10:37 PM

[Dan27:]

This "plan" is almost criminal. I live in South Florida and have watched the price of condos go from under $100k to over $400k in 7 years. Meanwhile the median income here is under 50k, and none of our teachers, firemen, or paramedics could even dream of owning a home due to the 7 year run-up in prices. Now the prices are finally just starting to correct toward being remotely affordable, and the government wants to try and stabilize prices?!?! And this is supposedly to help the "little guys." Guess what, the little guys need affordable housing, and Paulson is trying to prop up bubble level prices. They did nothing to help with affordable housing during the run-up, and now that the market is trying to self-correct, they want to prop up the artificially high prices that they helped create. Again I'll say, this is criminal.

2007 Dec 06 10:38 PM

[Dan27:]

This "plan" is almost criminal. I live in South Florida and have watched the price of condos go from under $100k to over $400k in 7 years. Meanwhile the median income here is under 50k, and none of our teachers, firemen, or paramedics could even dream of owning a home due to the 7 year run-up in prices. Now the prices are finally just starting to correct toward being remotely affordable, and the government wants to try and stabilize prices?!?! And this is supposedly to help the "little guys." Guess what, the little guys need affordable housing, and Paulson is trying to prop up bubble level prices. They did nothing to help with affordable housing during the run-up, and now that the market is trying to self-correct, they want to prop up the artificially high prices that they helped create. Again I'll say, this is criminal.

2007 Dec 06 10:43 PM

[Dan27:]

This "plan" is almost criminal. I live in South Florida and have watched the price of condos go from under $100k to over $400k in 7 years. Meanwhile the median income here is under 50k, and none of our teachers, firemen, or paramedics could even dream of owning a home due to the 7 year run-up in prices. Now the prices are finally just starting to correct toward being remotely affordable, and the government wants to try and stabilize prices?!?! And this is supposedly to help the "little guys." Guess what, the little guys need affordable housing, and Paulson is trying to prop up bubble level prices. They did nothing to help with affordable housing during the run-up, and now that the market is trying to self-correct, they want to prop up the artificially high prices that they helped create. Again I'll say, this is criminal.

2007 Dec 06 10:54 PM