December 6, 2007

By William Neikirk and Mary Umberger

Faced with a wave of costly home foreclosures, the Bush administration and financial institutions on Wednesday agreed to a five-year freeze on interest rates for certain Americans who face default on their subprime mortgages.

The unprecedented accord, to be announced Thursday by President Bush, is aimed at curtailing the economic damage from the bursting of the housing boom during which many marginally qualified borrowers used easy credit to buy homes and now can’t afford the mortgage payments.

The freeze would enable eligible mortgage holders to pay only their initial, lower “teaser” interest rate for the next five years so that they will not face sharply higher payments when their interest rate is “reset” to a higher rate. More than a million such loans are scheduled to be reset over the next year.

With more than an estimated $1 trillion worth of subprime loans outstanding, the U.S. housing industry is facing a crush of defaults in 2008. The Center for Responsible Lending estimates that 1 in 5 subprime mortgages made in 2005 and 2006 will end in foreclosure.

But not every homeowner with a subprime mortgage would qualify, only those who are current with their teaser-rate payments and can’t afford a higher interest rate.

Those who have been delinquent on their current loans would not be eligible for the freeze, according to a source briefed on the plan. These loans would be worked out with lenders on a “case-by-case” basis, but many would likely end up in default. Another source said that borrowers with a 60-day loan delinquency would not be eligible for the freeze.

The freeze would apply to adjustable-rate mortgages originated between Jan. 1, 2005, and July 31, 2007, which would reset between Jan. 1, 2008, and July 31, 2010. The program is designed to help those with two-year or three-year low teaser rates on their mortgages.

It would only affect borrowers living in their homes, not those who purchased housing for investment purposes. According to the source briefed on the plan, those who have a 3 percent equity stake or more in their property also would not be eligible for the freeze.

Under the reasoning of federal officials, those who currently have financial wherewithal to make their payments but would struggle to pay a higher reset rate could qualify for refinancing.

The Bush administration is expected to seek authority to enable state and local governments to use tax-exempt bonds to fund these refinancings, an idea floated by Treasury Secretary Henry Paulson in a speech on Monday.

The voluntary agreement caps a lengthy negotiation between the government and key players in housing finance, including lenders, loan-servicing companies, investors and trade associations. The government wanted investors, chiefly bondholders, to go along with the plan on the grounds that some return on their investment is better than none.

Sen. Charles Schumer (D-N.Y.), chairman of the Joint Economic Committee of Congress, singled out investors as the biggest problem.

“The loan freeze is a good first step, but the $64,000 question remains: Will investors who might balk at going along with this be able to maintain legal roadblocks and prevent the plan from going into effect?” Schumer asked.

Lyle Gramley, a former Federal Reserve member and formerly chief economist for the Mortgage Bankers Association, said financial institutions who collect loan payments would need “legal assurance that bondholders are not going to sue them.”

According to one source, the Bush administration will give its blessing to a bill by Rep. Mike Castle (R-Del.) that would provide such protection.

Rep. Judy Biggert (R-Ill.), a member of the House Financial Services Committee, helped write a letter to those involved in the negotiations urging that “to the maximum extent possible, we want to rely on market-based solutions to this [housing] problem and limit the use of government funding to address this need.”

The administration carefully sought to avoid the charge that it was bailing out the industry, since no government money would be involved. But the key role played by Paulson gave the plan a strong government flavor.

Sen. Hillary Clinton (D-N.Y.) and former Sen. John Edwards (D-N.C.), both presidential contenders, have proposed similar plans to deal with the housing crisis.

Jim Ellis, a finance professor at DePaul University, questioned the value of the plan, saying studies show that a high percentage of those having trouble making mortgage payments ultimately default.

Geoff Smith, research director of the Woodstock Institute in Chicago, which has studied the effects of foreclosure in the region, said, “We’ve been very supportive of this idea in general — the idea of some sort of systematic loan modification. Working with borrowers on a case-by-case basis is not efficient.”

Characterizing the program as “a start,” he estimated that it could affect 10 percent of subprime adjustable-rate borrowers who are facing reset troubles.

“For us, that 10 percent seems low, and we would hope that [the program] would cover a larger number of people,” Smith said. “But I think it’s an appropriate kind of program to help borrowers who are not yet in foreclosure. It makes a lot of sense to us.”

But Dan Lindsey, supervisory attorney for the Home Ownership Preservation Project of the Legal Assistance Foundation of Greater Chicago, said he was skeptical of the voluntary nature of the program because his group has encountered resistance from lenders in working out terms to stave off foreclosure for individual borrowers.

“It’s hard to express the frustration we experience, the incredible gulf between what we hear high-level people say at a meeting about what their companies are able to do [to help borrowers in trouble] and, when they have a live human being in this situation, they become unwilling,” Lindsey said.

“There is a chasm between the policies that are set at the top and what homeowners actually experience on the front lines,” he said. “If it’s voluntary, I have not much hope. I think it will help some people at the margins, but I think it needs to be mandatory.”

Paul Leuken, president of the Illinois Association of Mortgage Professionals, based in Lombard, said he expected the plan to be helpful.

“Anything — whether it’s government or investors or banks — anything they can do to try to help the consumer is a good thing,” Leuken said.

“Some people feel, well, they made their bed and they can sleep in it, but what people don’t realize is that if the average home buyer who has good credit is going to fail, it’s going to hurt everybody,” he said. “We need to figure out a solution, not just let them sink or swim.”

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