The Associated Press reports that George W. Bush is scheduled to announce a plan to rip up the mortgage contracts of some homeowners and let them continue to pay the teaser rate for the next five years. Few details are known, but AP reports that the "rate freeze will apply to loans made to borrowers who did not miss any payments at the lower rate who took on loans between the start of 2005 and July 30 of 2007 and will cover loans that had been scheduled to rise to higher rates between January 1, 2008, and July 31, 2010."
Before analyzing the winners and losers under this plan, it's worth examining why Bush is doing this. As I posted previously, I think it's about his legacy. And in this case, it's about beating his father. In 1989, George H. W. Bush implemented a $200 billion government bailout of the Savings & Loan industry. The son aspires to bail out the subprime mortgage business without spending any government money.
There is one big winner and four big losers in W's plan.
Winners
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Frozen mortgage holders. The unknown number of mortgage holders who have been making their payments will be rewarded by getting their teaser rates extended. It's unclear how many of these people actually would be unable to pay the higher rate that they contracted to pay when they signed the mortgage. But these borrowers are getting a government-forced bailout from the investors in their mortgage contracts.
Losers
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Mortgage-backed securities (MBS) owners. Anyone who happens to own the rights to the mortgage payments from the mortgages covered by W's plan will take the biggest hit. When these investors bought the mortgages, they anticipated that the rates would reset upwards. Now they will have to take a write-down on their MBS based on the loss of income they had anticipated.
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All other mortgage holders. All other mortgage holders will wonder why they were passed over for W's intervention in their mortgage contracts. For instance, why should a class of borrowers who happened to sign a contract during the period covered by W's plan get special treatment? And if the government is going to bail out someone, why not let it be a borrower who is having trouble making payments at the teaser rate?
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Free markets. W's plan thumbs its nose at the notion of free markets. It allows the free markets to work for borrowers not covered by the plan, while replacing free markets with government intervention for those borrowers who happen to have lucked into being in the class of people the plan covers. And if the plan was intended to limit the number of foreclosures, it's not clear that it will succeed at that. That's because the people who have not been able to make their teaser payments are more likely to foreclose. While the ones being helped by the plan -- those who are making their payments -- would have been more likely to afford to pay the higher reset amount in their original mortgage contracts.
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George W. Bush's legacy. Given the damage W's plan is likely to cause for these "losers," George W. Bush's legacy is also likely to take a hit. Fortunately for him, in the absence of more details. it is difficult to know whether his plan will actually go into effect or if -- like his SIV rescue plan -- it will stall. One thing seems clear, whichever group is left out of the plan -- and this appears to include MBS investors -- will resist its implementation.
While I applaud him for trying to do something, I think there's a chance to do something better. What do you think?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
12-06-2007 @ 10:47AM
Chris said...
I think this plan stinks. It penalizes MBS holders and those who were RESPONSIBLE with thier money. It flies in the face of conservative free-market principles and is morally questionable. Why, again, are we bailing out people who bought more of a house than they could afford? This boggles my mind. Housing prices must fall back into line with salaries (fundamentals). This plan just delays the inevitable.
I am a conservative republican, and I strongly disagree with Bush on this. This is something I would expect from the Democrats. The whole thing stinks of politics. I bet the whole "sub-prime" mortgage crisis would not even be getting any attention from politicians if there were not a major election cycle coming up.
12-06-2007 @ 11:00AM
Dan said...
I'm a conservative and I think this is actually a pretty good plan. And the reason is because of something you misunderstand about it. It is not a forced government bailout. It is an agreement between the government, the mortgage industry, and the banking\investing industry. And, according to the WSJ and Bloomberg, it is
1. optional
2. non-binding
And it has the support of major investors. So basically what Bush did is sit down with the industry and carve out an agreement that all could live with.
While I agree that the homeowners who got themselves into this mess are getting a huge break that is pretty much undeserved, the facts are that MBS holders, the banking industry, etc would have suffered much more if these mortgages were foreclosed on. This is is actually an effort to limit government's involvement in the problem, not expand it.
Will it work? I don't know. But it is much better than some of the more liberal plans to force a freeze on rates and on all foreclosures for six months.
12-06-2007 @ 11:05AM
friendorfoe said...
I hope that in this all we can remember that if you god forbid had to move in 2003-2005 you were forced to pay top dollar for a home even if it was not your dream home. The only other choice you had was to rent from a landlord who most likely had also paid top dollar and was asking you to throw in some cases thousands of dollars into his funds every month. I know that we are all entitled to our opinions and should voice them that is what makes this country great. However I feel that you should take into account the situations that these people were in and by the way I myself made no housing changes in this time so it in no way helps me but it helps a lot of my neighbors and community which I feel is equally important.
12-06-2007 @ 11:39AM
ajgorm said...
Inventories of homes will decrease with time. Some areas will experience little economic growth. The growth will be where jobs exist. Renters will want to buy a home picking up demand sooner than we think.
Legal issues questioning the legality of freezing rates is going to be hard to manage. Subprime home loan owners during foreclosure should ask and have the right to rent or lease (option to purchase) the home back reducing or limiting the banks losses.
12-06-2007 @ 12:14PM
David Huston said...
I think all of the teaser rates on all of the variable rate mortgages ought to be frozen for 5 years, without reference to the homeowner's ability to pay in the future or track record. That's the only way to even-handedly and effectively intervene in the housing crisis, which otherwise may turn into a depression for all of us.
12-06-2007 @ 2:50PM
Maurice Leacock said...
Overall it sounds like a good plan but to the point raised in the original article, it seems rather arbitrary that the period starts at 2005, spanning to July of this year(?) and covers re-indexing between next year and 2010. I agree that it should cover those that make regular payments (as the folks that are missing payments even at the teaser rate would not get better at paying their mortgages simply because their payment stays the same), but their were an awful lot of folks in the 2003 / 2004 time frame that needed to purchase a home and were at the mercy of the skyrocketing prices and stiff-arm lending.
Minor tweaks George . . . minor tweaks are all that are needed to make this one a little more agreeable and something that might help put some of the shine back on your legacy.
12-20-2007 @ 11:46AM
pgoossen said...
I believe the government should help in the form of tax deductions for people paying down principle in mortgages, sure...this would only help out those that can afford their homes, but it will give more liquidity to the market. Everything else is supply and demand, homes are not intended to appreciate in the short term. I remember my realtor saying "you should stay in your home 7 years to make it a worthwhile investment", many who speculated or refinanced to support their consummerism greed (buying more things) are now forclosing.
Question: Every financial analyst mentions to not pay down your house, many other long-term investments are more lucrative (401k, some stocks etc), only when money is left over, pay down your house. Could I get your thoughts on this?
12-22-2007 @ 6:25PM
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