Fixing the foreclosure crisis
Because homeowners are also voters, and because the subprime lending crisis threatens the whole economy, the federal government is trying to come up with ways to head off a massive foreclosure crisis. Last week the treasury secretary was meeting with lenders, trying to negotiate a change in the rules.
As I described yesterday, structured loan products have changed the incentives for banks, so that it is often more profitable for them to foreclose on a loan than to workout an alternative payment schedule--even when rescheduling the loan would bring in more money than a foreclosure--because people who got the loan payments were anonymous investors, while the bank got the same fee whether it did a cheap by-the-book foreclosure or put time and effort into arranging restructurings one by one.
The best solution would be to restore those incentives: change the rules so that trusts can renegotiate loans, change the rules so that the banks have an incentive to get the best return, change the rules so that the people who do the work of renegotiating get paid for that work. Some of those things may happen, but some of the changes are not popular, and all of them are hard to arrange after the fact.
Because the nature of piecemeal fixes make them hard to mandate, the government is trying to come up with some sort of "big fix" to make the problem go away. One thing they're thinking about doing is extending low teaser rates.
Treasury Secretary Henry Paulson has been trying to negotiate an agreement to not have adjustable mortgages reset to higher rates. There are many different proposals regarding how long the resets would be held off (three years and seven years have both been mentioned) and no clear rules yet on who would qualify for the freeze.
This is a pretty bad solution.
The details are still being worked out, but it seems to be targeted at people who kept their loan up-to-date until the rates reset, and then started having trouble.
This sort of strategy creates problems of fairness--does the family where the parents took their kids out of private school and both got second jobs so they could stay current on their mortgage get no relief, because they've managed to scrape together each payment so far? How about a family that refinanced their mortgage to pay off credit cards, then maxed out their credit cards again? Does it make a difference if they maxed out the credit cards to pay for medical treatments after an accident?
It also creates problems of free riders--if missing a mortgage payment could cut your rate in half for five years, it'd be awfully tempting to find a way to miss that payment.
It's also bad for lenders whose profits depend on the rates adjusting. Even though it's tempting to stick it to companies stupid enough to use low teaser rates to trick people into taking out loans they can't afford to pay back, it's still bad public policy to change the rules like this. And, of course, the people who lose are the shareholders of those lenders--which includes ordinary people and their pension funds.
Finally, it's not at all clear that any of this would be legal. As I mentioned yesterday, the trust documents that created these packages of loans often don't allow the managers to change the terms. As far as I can tell, the treasury secretary isn't making any effort to get congress to write a law that allows for teaser rates to be frozen, and I don't know of any power inherent in the treasury to allow the secretary to do so. It seems like they're talking about just doing it, and hoping that if everyone does it, nobody will sue. It's a nice theory, but in my experience, things don't work like that in the United States.
At the same time, the Federal Reserve has been signaling (in speeches by both Vice Chairman Kohn and Chairman Bernanke) that a further rate cut can be expected in December. That may help around the edges. Lower rates would reduce the amount that adjustable mortgages would adjust. It also makes it cheaper for lenders to raise funds, which means less of a profit squeeze if they do end up freezing low teaser rates.
Of course, the Fed being too aggressive in lowering rates and too timid in raising them again was the biggest single factor in getting us into this mess, so it's hard to feel all warm and fuzzy about them doing it again.
If you've actually got a mortgage that's in danger of foreclosure, the real news here is that the federal government is leaning on lenders to do what they can to keep you in your house. If you're living in a house that you can't afford, it's probably a mistake the keep throwing money into house that you'll eventually lose anyway. On the other hand, if you like your house, and if you could afford it if the rate weren't so high, keeping it may be more of an option now than it was a few months ago. The treasury is pushing a program called HOPE NOW that's trying to educate people to try to workout the loan problems. If you're in danger of foreclosure, check it out.