What the Mortgage Bailout Means For
You
As the Bush Administration unveils its plan to help
homeowners, we look at the proposal's details
On Dec. 6, Treasury Secretary Henry Paulson, with the support of President
George W. Bush, unveiled a plan to aid certain homeowners who face the
prospect of higher mortgage rates in the next few years. Paulson worked with
banks and other mortgage companies to develop the initiative, and thanked them
for their involvement. "We have worked through an evolving process to help
minimize the impact of the housing downturn on homeowners, neighborhoods
and the U.S. economy," he said. While the plan is ambitious and is designed to
bring stability to the shaken economy, it will affect only a narrow slice of
homeowners in the U.S. "This is not a silver bullet," said Paulson. Here are some
answers to questions you may have.
Can you get your mortgage payments lowered because of the bailout?
It depends. If you've got an adjustable-rate mortgage, you may qualify under
certain conditions. If you've got a standard mortgage with a fixed interest rate,
you're not affected.
Which adjustable-rate mortgage holders are affected?
Only a small group. To qualify, you need to have received your loan sometime
between Jan. 1, 2005 and July 31, 2007, and you need to be facing a reset of
your interest rate sometime between Jan. 1, 2008 and July 31, 2010. If you're
within this range, you may be eligible to have your interest rate frozen, so you
can keep your current, lower rate for five years.
Who qualifies within that range?
The bailout is really designed for homeowners who could run into trouble if their
mortgage payments are raised sharply and face the prospect of losing their
homes. If you're well enough off that you can afford the higher mortgage
payments after a reset, you won't qualify. And if you're in bad enough shape that
you can't handle the current low interest rate, you won't qualify. For example, if
you've already fallen behind on your mortgage payments, you're not eligible for
the rate freeze.
Do you need to live in your home to qualify?
Yes. The plan excludes people who don't live in the homes for which they have
mortgages so that speculators can't benefit.
Why is there going to be a bailout?
Bush, Paulson, and the Administration are concerned about the fallout from the
housing slump. If many people fall behind on their mortgages and have to give
up their houses, there will be a series of negative repercussions. First, tens of
thousands of Americans could be forced to leave their homes. They would lose
whatever equity they had. Consumer spending more broadly would likely slow,
hurting the economy overall. In addition, home prices could fall even more
quickly than they are now. That could hurt consumer confidence well beyond
those people directly affected.
Is the bailout going to be enough?
It depends on your definition of enough. The deal will add some stability to the
housing market, but it won't stop all the problems in the troubled sector. The
same day Bush unveiled his plan, the Mortgage Bankers Assn. said that
foreclosures had reached a record high in the third quarter. The share of
mortgages that have entered foreclosure hit 0.78% in the quarter, up from the
previous high of 0.65% set in the previous quarter. At the same time,
delinquencies for all mortgages rose to 5.59%, from 5.12%, in the second
quarter. None of the people who are delinquent or facing foreclosure will be
helped by the plan.
The deal almost certainly won't stop the decline in housing prices. Investors are
betting that there will be double-digit declines in home prices in nine of 10 major
markets over the next year. The only exception is Chicago, and there the
estimate is for a 5.6% drop in home prices.
So why not go further?
Some Democrats are criticizing the Bush Administration on that exact point.
Senator Hillary Clinton (D.-N.Y.), among others, is arguing for a more ambitious
approach, including at least a seven-year freeze on interest rates.
Who stands in the way of such an effort?
Investors in mortgages and mortgage-backed securities. If homeowners are
going to pay less on their mortgages than originally planned, then somebody is
going to lose money. These aren't just fat cats on Wall Street—although many
such firms have invested in these securities—they're also pension funds for
teachers, firemen, and police, as well as mutual funds whose clients include all
sorts of individual investors. They probably even include homeowners who are
facing the prospect of higher payments on their adjustable-rate mortgages.
Does the Housing Plan Go Far Enough?
Even as Paulson unveils his long-awaited plan to help
homeowners, there are many questions
With the growing mortgage crisis threatening to send the economy into a tailspin,
help is on the way. On Dec. 6, Treasury Secretary Henry Paulson announced a
much anticipated plan aimed at preventing a wave of foreclosures among
homeowners facing sharply higher monthly payments on adjustable-rate
mortgages that will soon reset.
The plan, unveiled with Housing & Urban Development Secretary Alphonso
Jackson and with the blessing of President George W. Bush, comes after weeks
of tough bargaining with lenders, investors in mortgage-backed securities, and
loan servicers—the folks who collect mortgage payments for investors.
The centerpiece of the initiative is an agreement by lenders to freeze interest
rates for up to five years for at least some portion of the 1.8 million subprime
borrowers in danger of losing their homes as their mortgage payments spike up
by the end of 2009. Borrowers who qualify for assistance will have their interest
rate frozen at the initial starter rates, which generally run between 7% and 9%.
"We have worked through an evolving process to help minimize the impact of the
housing downturn on homeowners, neighborhoods, and the U.S. economy," said
Paulson. "The infrastructure to reach struggling borrowers is now in place."
Standard Criteria to Speed Process
Reaction to the plan was mixed. While Democrats on Capitol Hill and on the
campaign trail argued it didn't go far enough, some conservatives decried what
they see as overstepping by the government in pushing the private sector into
agreement. Still, many in the mortgage industry were relieved to see movement.
Although plenty of questions remain, Rod Dubitsky, managing director of fixed
income research for structured products at Credit Suisse Securities says, "This is
a good start."
Critical to the plan's success is how quickly it will speed the workout process for
homeowners—and for how many. Until now, loan modifications have been
painfully slow. Because many lenders have been overwhelmed by the number of
borrowers already running into trouble—and they've been dealing with those
borrowers on a case-by-case basis—only a minuscule number of homeowners
facing default have been able to renegotiate their loans. The idea of the workout
plan is to speed up the process by laying out standard criteria under which
homeowners will be eligible for aid. "We hope that these guidelines will be
adopted as reasonable and customary standard practice across the entire
servicing industry," said Paulson.
Not every troubled homeowner troubled homeowner need apply. For starters, the
rescue plan will only apply to homeowners who took out adjustable-rate subprime
loans between January, 2005, and July, 2007, and which are resetting between
January, 2008, and July, 2010.
A Small Group Will Benefit
Within that group, those who will be able to continue to pay their mortgages even
after resets won't qualify for relief. Neither will those already struggling to pay
their mortgages even before resets; they, too, are out of luck.
Instead, the plan will concentrate on two groups. Those with enough equity in
their homes, or enough income, to be able to refinance will be fast-tracked in new
loans.
But the core of the relief effort will be targeted at those who are currently paying
their mortgages but will be unlikely to be able to continue doing so after the reset.
To screen for those who potentially qualify, servicers will focus on those who are
no more than 30 days delinquent on their current loans, and had equity of just
3% or less in their homes at the time the loan was made. Lenders will then look
at financial criteria—primarily a homeowner's FICO score—to determine whether
they are eligible for the rate freeze. "This will allow us to move through the cases
much faster," says Michael Heid, co-president of Wells Fargo Home Mortgage.
The plan's details raised as many questions as they answered. Chief among
them: Given those restrictions, just how many homeowners will be helped? "The
plan seems like it will help reduce foreclosures, but the question is how much,"
says Alec Phillips, a Washington policy analyst for Goldman Sachs. According to
Heid, holders of roughly 1.2 million of the hybrid ARMs scheduled to reset could
get some form of assistance. He says roughly 600,000 will likely have their loans
refinanced, while a "significant portion" of the remaining 600,000 will benefit from
an interest rate freeze. Informal industry estimates place the number somewhere
between 240,000 and 500,000.
How Well Will It Work?
Heid, who played a key role in helping negotiate the deal, believes it will go a
long way toward helping struggling homeowners. But many bankers and those in
mortgage services continue to question how well a systematic approach will
work. Even with broad criteria in place that help identify those potentially eligible
for a workout, many say actually going through the details of renegotiating a
mortgage will remain an intensive, loan-by-loan process. They argue they will still
have to look at such things as whether the value of the house has fallen, along
with the disposable income and debt level of the borrower, to complete a
workout.
"There's only so much that can be done from Washington," says James
Montgomery, who was chairman of Great Western Financial when it was sold to
Washington Mutual in 1997, and who has since founded two community banks in
California and Utah. "You've got to look at deals individually, and at local market
conditions."
Some housing advocates also decried what they see as the plan's narrow focus,
arguing that far too many people will be excluded from help.
Satisfying Investors, Not Homeowners
"This crisis is likely to be the worst we've seen since the Depression, but [the
plan] is only dealing with the easiest slice of borrowers," says Michael Shea,
executive director of Acorn Housing, a national housing advocate group based in
Chicago. "What they are proposing won't help a single soul who is currently
delinquent on their mortgage or facing foreclosure. We need bold proposals like
the ones set by FDR during the Depression. What we are getting is Calvin
Coolidge."
Shea argues that too much of the focus has been on satisfying investors, rather
than saving communities and homeowners. But there are also big questions
about how happy investors in mortgage-backed securities will be with the plan.
Indeed, a big stumbling block to workouts so far has been the fear by loan
servicers—who manage the pools of mortgage-backed securities—that they
could be sued by investors in those securities who might be worse off if a loan is
modified. "You will see class-action lawyers salivating over this," says Bert Ely, a
longtime consultant to financial institutions.
Manageable Risk of Litigation
Regulators have argued that everyone—lenders, homeowners, and investors—
are better off if homes are kept out of foreclosure, even if the mortgage-backed
securities pools have to take some loss. And regulators have tried to convince
servicers that they generally have the contractual right to modify loans without
fear of lawsuits.
Paulson said such fears should not inhibit the plan. "These industry standards
announced today are the product of discussions among investors and servicers,"
he said. "With the investor community on board and as a clear beneficiary of this
approach, the risk of litigation should be manageable."
Not all servicers have been convinced, however, that they won't face a wave of
lawsuits from investors who will lose income or see the value of their investment
drop when rates are frozen. Ratings agency Standard & Poor's also points out
that freezing rates could have a negative effect on the ratings of some mortgage-
backed securities.
Varied Interests Among Investors
Representative Michael Castle (R-Del.) has pushed for legislation to protect the
companies that make or service mortgage loans from being sued. "Foreclosure
benefits almost nobody—from the homeowner, to the neighborhood, to the
lender. And, frankly, I don't think it benefits whoever bought the security. There
are varied interests among investors, however. Even if an overall pool of
mortgage-backed securities is better off under the bailout plan, holders of some
slices of the debt within a pool may lose more than they would in the case of
foreclosure.
"Everyone wants to say this will be a win-win, that doing workouts will be better
for investors in the mortgage loans, and better for the homeowners," says Mark
Adelson, a longtime specialist in structured finance at Nomura who recently
started his own consulting firm, Adelson & Jacob. "Sometimes that's true, and
sometimes it's not. What everyone seems to be ignoring is that plenty of times,
it's not advantageous to the holder of the loan to do a modification."
"Not a Silver Bullet"
There are also worries that investors burned by losses from such workouts, and
angered that the rules of the game changed midway, will shy away from the MBS
market in the future. That could hurt liquidity and lead to higher rates. Ely points
out that enormous flows of foreign capital have come into the U.S. housing
market in recent years, bolstering prices. But it's far from clear why a bond
investor investor in Germany should suffer losses to help out some guy in
California who bought a house with barely any equity.
Despite those risks, the rising political pressure to head off a massive wave of
foreclosures likely to hit in the middle of campaign season meant the mortgage
industry had little choice but to sign on to the high-profile plan. If foreclosures
continue to soar, Jaret Seiberg, a policy analyst with the Stanford Washington
Research Group, points out, the industry faces the possibility of much harsher
regulatory measures from Congress. A bill currently before Congress that would
allow the modification of home loans in bankruptcy, including the writedown of
principal, could gain momentum if the situation worsens.
Paulson was clear that the plan won't solve some of the most difficult problems in
the housing market, including the declines in home values in certain parts of the
country. "This plan is not a silver bullet," he said. "What five years does is give
this country a chance to work through a housing cycle."
Investors Back the Bailout, Cautiously
Bondholders aren't exactly thrilled, but the surrender
of some interest income now may help protect their
principal later
Many investors take for granted that government should intervene as little as
possible in the workings of the financial markets. Still, they are inclined to see the
Bush Administration's decision to spare hundreds of thousands or mortgage
holders from higher rates as the best of several unpleasant alternatives.
The five-year rate freeze announced Dec. 6 will lighten the load for homeowners
who took out adjustable rate mortgages over the last three years and face
massive rate resets between January, 2008, and July, 2010. In many cases,
those rates are scheduled to rise from the 7% to 9% range to the 11% to 13%
range. On, say, a $300,000 mortgage, that could jack up monthly mortgage
payments by $800 to $900.
To qualify for the rate freeze, homeowners must meet an exacting set of criteria:
They must be no more than 60 days late on their loan. They can't have had more
than 3% equity in the home when the loan was made. Their FICO credit rating
score, named for benchmark developer Fair Isaac, can be no higher than 660.
Creating a Safety Net
By lowering anticipated interest payments, the plan will cut off a wave of revenue
that was scheduled to flow into mortgage-backed securities. That alarmed credit-
rating agencies such as Standard & Poor's, which warned on Thursday that the
ratings of some mortgag-backed securities could fall as a result of the bailout.
For the most part, investors appear willing to accept lower interest payments in
exchange for some reassurance their entire investment in lenders or mortgage-
backed securities won't be wiped out. In other words, the alternative to reduced
interest income could have been a total loss of principal on some investments.
"There is a serious problem with delinquencies over the next few years. Without
action, many bondholders may not have gotten their principal. Now they have a
better chance of getting paid back," says Joseph LaVorgna, chief U.S. economist
at Deutsche Bank (DB).
Equity investors seem to accept the necessity of the bailout as well. "There will
be some protection for investors. With this plan, the risk of a particular company
going bankrupt is lower," says Bob Doll, global chief investment officer for
equities at asset manager BlackRock (BLK). "It is creating some safety net.
These are steps in the right direction." Doll is on the hunt for shares of beaten-
down financial firms that may have a good chance of bouncing back.
Stemming the Tide of Delinquencies
There are bound to be some disruptions as a result of such large-scale
government tinkering with the financial markets. Lisa Nelson, vice-president for
scoring solutions at Fair Isaac, says lenders are nervous investors will be scared
away from the mortgage-backed securities market, making it harder for lenders
to sell their loans. That could limit the money available for future lending.
But the alternative appeared to be much worse. The prospect of higher
delinquency rates and a greater risk of recession scared the markets more than
the uncertainties of government intervention. There's no guarantee the worst
outcome can be avoided. But coupled with lower interest rates, investors seem to
think they have a fighting chance.
The subprime suckers who paid on time
I predict a rising backlash by on-time subprime borrowers against the Bush
administration’s Teaser Freezer bailout plan. As far as I can tell, on-time
borrowers wouldn’t be helped, even if they are severely stressed. The aid would
go only to people who had missed payments. So if you scraped up every last
dime to make every mortgage payment, you’re stuck in your lousy loan. Your
next-door neighbor who spent the mortgage payment at Disney World gets the
bailout. Infuriating, huh?
That’s a bit of an oversimplification, of course. The Bush Administration plan is to
streamline the workout process, not change the rules entirely. Presumably, then,
not everyone who’s current will be ineligible for help, and not everyone who blew
a payment will get aid.
Inevitably, though, any nationwide solution is going to create some winners and
losers. And the losers are going to be yelping pretty loudly.
Read this complaint from a guy who got a prudent fixed-rate loan even though it
was more expensive than a teaser ARM, knowing that ARMs would reset
upward. Now he’s steamed that ARM borrowers are going to get away with
below-market teaser rates for the next five years.
Peter Schiff, a perma-bear who rails against America’s overspending ways,
thinks that some of the people who were bailed out are going to end up
defaulting when the rate freeze ends in five years anyway, and knowing that they
won’t take care of their properties. He calls it “the mother of all bad ideas.”
Here’s what he wrote today:
Compounding the problem is that subprime borrowers with frozen payments on
loans that exceed the values of their homes will likely chose not to pay property
taxes, condo or homeowners fee, or maintain the condition of their properties.
Were these properties to be sold in foreclosure at least their new owners would
have financial incentives to maintain the value of their investments. Upside-down
subprime borrowers will have no incentive to throw money down a rate hole,
making additional payments on properties in which they have no equity and
which will they will likely lose to foreclosure anyway. When these homes do go
into foreclosure, back taxes and other fees on dilapidated properties will inflict
even greater losses on lenders.
Also, subprime borrowers with frozen resets will be unable to either
borrow additional money against their homes or sell them. As rising
credit cards payments, higher food and energy bills, and stagnating
wage growth or even unemployment make even paying the frozen
rates increasingly more difficult, this lack of flexibility will prove fatal.
Also the moral hazard inherent in offering help to only those who
can demonstrate an inability to afford the reset rates, or restricting
the bailout to borrowers with low credit scores, guarantees that
borrowers will alter their circumstances to qualify for the aid.
Therefore more loans will be frozen than is currently forecast, and
the circumstances of the financial borrowers will be that much more
impaired as they endeavor to pile on added debt or reduce their
incomes to conform to the requirements of the bailout.
Lost in current discussion is the fact that few subprime borrowers
have any skin in the game in the first place. Having put nothing
down or having extracted equity in previous refinances, most
subprime borrowers will lose nothing if their homes go into
foreclosure. In some cases the teaser rates were so low that
borrowers actually paid less then what they might otherwise have
paid in rent. In fact, those who have already extracted equity have
received huge windfalls from their homes and will leave their
lenders holding the bag.
At today’s conference, Treasury Secretary Henry Paulson acknowledged in
response to a reporter’s question that the fairness issue has already come up:
“We’ve heard a number of comments like that,” he said.
His response is that something had to be done about the foreclosure mess and
there’s no silver bullet. First, Paulson said that preventing unnecessary
foreclosures is good not only for the homeowners, but for their neighborhoods.
Second, he said that a lot of the anticipated workouts would have been done
anyway, except more slowly. His implication is that the inequity isn’t any greater
than it was in the past.
Actually, both arguments are questionable. There are times when foreclosure
really is the best option, as Peter Schiff’s comment makes clear. And despite
Paulson’s argument that this is purely a private-sector deal, it seems pretty clear
that loan servicers are going to feel under heavy political pressure to go easy on
homeowners. Once investors realize that they can’t trust their loan servicers to
get them as much money possible, they’re going to be more cautious about
buying mortgage-backed securities, and the flow of money going toward
financing homeownership will slow.
Here’s what Standard & Poor’s said about the plan today.
Although loan modifications that extend the mortgage’s fixed-rate
period may result in lower defaults, the reduction in excess spread
may offset the benefits of lower defaults resulting in diminished
investor protection.
Now, putting a little fear into the mortgage-backed market is not an entirely bad
thing: there was probably too much investment in housing over the past five or
six years.
Funny thing, though. You don’t hear President Bush bragging that this plan will
keep zombie homeowners in their dwellings for another half decade while drying
up the money necessary to help people buy homes in the future.
A Resolution Trust Corp.-style bailout might have been a cleaner way of dealing
with this mess. Makes me wonder whether in its zeal to come up with a solution
that could be labeled 100% “private sector” for political consumption, the Bush
Administration made some poor choices.