The Upcoming Financial Quagmire
By Pejman Yousefzadeh Posted in Economy | Subprime Mortgages — Comments (6) / Email this page » / Leave a comment »
Regulation of the mortgage industry has suddenly become the cause du jour among the political class. Consider, for example, this article, which discusses Hillary Clinton's fire and brimstone condemnation of the mortgage industry and her solution to the subprime crisis:
Clinton repeated her call for a voluntary agreement that would call for a moratorium of at least 90 days on foreclosures of subprime, owner-occupied homes; a freeze on the monthly rate on subprime adjustable rate mortgages, with the freeze lasting at least five years or until the mortgages have been converted into affordable, fixed-rate loans; and an agreement by the industry to provide status reports on the number of mortgages it is modifying.
"If we cannot reach a voluntary agreement [with Wall Street], I will consider legislation to address the problem," she says in her text. "Mortgage servicers can work with borrowers to modify their mortgages. In the process, they can save families their homes, save investors from losses down the road, and help the economy. ... So I am prepared to consider giving legal protection to servicers and others who administer these loans and who do the right thing by balancing the interests of the homeowners, the investors, and our economy."
Read on . . .
The White House is working on a plan to freeze interest rates on certain subprime home loans, though it faces significant hurdles that could derail its implementation, according to industry executives and others familiar with the situation.
The plan, being discussed by the Treasury department and other regulators, along with mortgage lenders, servicers and investors, is designed to forestall a potential crisis when introductory "teaser" rates on nearly $400bn (272bn, £194bn) of high-risk subprime loans reset higher over the next year.
Under broad terms of the plan being pushed by Hank Paulson, the Treasury secretary, lower interest rates would be frozen for borrowers who met certain criteria, including the condition that they could not afford higher rates but might avoid default if they kept their current rates. This group is likely to include people who have missed one or two payments.
The plan would exclude those able to keep making payments at higher rates and perhaps those unable to keep up even if their rates were frozen. However, no final details have been set.
The White House said on Friday it was "premature" to discuss details of the plan. Jennifer Zuccarelli, a Treasury department spokeswoman, said there was broad agreement to come up with a more standardised approach to helping homeowners. Mr Paulson has discussed the plan publicly in recent days but offered few details.
Ah, but there are problems. Let us call the following the "Distorting The Market Is A Bad Idea--Example # 274,916,583" portion of this blog post:
Industry executives, market participants and several analysts said implementing any plan would be complicated and riddled with technical and political problems, including possibly encouraging otherwise stable borrowers to miss payments. "If you are a borrower in the group that gets left behind by this scheme, you have a set of perverse incentives to default in order to get the break. It has moral hazard written all over it," said Don Brownstein, chief executive of Structured Portfolio Management, a hedge fund.
Several mortgage experts also said categorising borrowers would be difficult, given that their financial information might never have been collected before. Also, a large percentage of adjustable rate subprime loans have already been sold to investors who would have to accept lower payments as part of the plan.
Pretty worrisome, eh? It gets worse:
There could also be political backlash if any final plan did not help the most strapped borrowers. Any plan that did not include such help could face opposition from prominent Democrats including Barney Frank, a representative from Massachusetts, and Charles Schumer, a senator from New York.
In a statement on Friday, Mr Schumer said: "This is the first time that the Bush administration is working towards a solution that meets the magnitude of the problem. But there is a $64,000 question: will investors go along with this plan? And if not, can they be compelled to?"
Read that last quote again. As my RedState colleague, Jeff Emanuel, pointed out, "compelling" investors to go along with a particular financial solution is indicative of an entirely misguided mindset. And yet, it is a mindset that is particular to one side of the partisan divide.
I do not lack sympathy for those who are under pressure thanks to the subprime crisis. Far from it. These people should talk to their lenders, many of whom are eager to help them with a solution. But the proposed bailout plans on both sides of the aisle have a whole host of problems attendant to them and market distortions are no way to address the subprime crisis. Quite the contrary--they would only serve to make a bad situation far, far worse. Indeed, Stephen Green helps explain further why the Administration's approach could be such a bad idea.