By MICHAEL M. PHILLIPS, SERENA NG and JOHN D. MCKINNON
December 7, 2007; Wall Street Journal
WASHINGTON -- In unveiling a plan to help more than one million struggling homeowners, the Bush administration and the mortgage industry have embarked on a controversial project: picking winners and losers from the rubble of the subprime-mortgage meltdown.
Under the deal, formally released yesterday, the industry would voluntarily help as many as 1.2 million homeowners who are heading for trouble paying their subprime mortgages but aren't yet lost causes. For some homeowners, loan-servicing companies will agree to freeze mortgages at their low introductory rates. In other cases, credit counselors or loan servicers will walk mortgage holders through refinancing processes.
The deal won't provide relief to many subprime-mortgage holders: These include borrowers who are now in foreclosure, have already refinanced their homes or are more than 60 days delinquent on more than one payment over the past year. In some cases, people with good credit scores will be excluded. Also left out are those deemed able to afford the higher interest rates scheduled to replace their introductory rates over the next two years.
The initiative could help stabilize falling home prices and rising foreclosure rates, buoy the mortgage market and provide a modicum of comfort to investors watching the housing crisis bleed into the broader economy.
But it also sets what promises to become a battle line as the subprime crisis plays out over the coming election year. Some critics, especially Democrats, say the plan doesn't go far enough to protect vulnerable homeowners against foreclosure. Others, including some homeowners, as well as those who have watched from the sidelines as home prices have soared in recent years, charge that the plan amounts to a bailout for financially reckless borrowers.
The agreement covers homeowners who have taken out subprime mortgages, those offered typically to high-risk borrowers. About 1.8 million subprime loans are adjustable-rate mortgages, or ARMs, that carry low introductory rates that are set to expire in the next two years and adjust upward. These ballooning mortgage payments would threaten to produce a wave of foreclosures and a spiral of lower home prices and tightening credit.
The housing crisis is spreading beyond this relatively small subprime universe, causing turmoil on Wall Street and raising the specter of an economic slowdown. In the third quarter, home foreclosures hit their highest rate since at least 1972, according to the Mortgage Bankers Association. Prime adjustable-rate loans -- not covered in the industry's rescue plan -- accounted for 18.7% of mortgages starting foreclosure, the second-highest proportion behind subprime adjustable-rate loans. The overall delinquency rate is the highest since 1986, with some 2.64 million borrowers nationwide behind on payments for their first-lien mortgages for residences.
Nouriel Roubini, an economist at New York University and chairman of research firm Roubini Global Economics, calls the plan "a step in the right direction." But Mr. Roubini says the plan won't turn things around. "Over the next three years, we're still going to see a housing recession that leads to defaults and foreclosures," he predicts. "Anything we do now is on the margins."
The agreement, which was hammered out with investors and mortgage companies under the auspices of the Treasury Department, is the centerpiece of the Bush administration's free-market approach to the mortgage crisis and may be as far as it is willing to go in the direction of a full bailout. But pressure is likely to increase as housing and the economy move to the top of the presidential-election agenda. Candidates such as Hillary Clinton, Barack Obama and John Edwards have come out with their own plans, all of which go further than the White House is willing to go so far.
Rep. Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, said he is concerned that the plan sends the wrong message by not helping borrowers who have maintained good credit scores. These scores can run from 300 (bad) to 850 (ideal). According to the plan, homeowners scoring 660 or above will be considered fit to pay their mortgages. Such a rule would punish people who have tried to avoid taking on debt they couldn't handle, Mr. Frank said. He called the decision a "grave error."
Under the new plan, Humberto Goncalves would be on the cusp. The electrician took out an adjustable-rate mortgage when he bought a home in Cranston, R.I., in 2005. He is current on his mortgage and thinks his credit score is about 660. Mr. Goncalves says he is already paying about $2,000 a month. "Anything to keep it from going up would be very helpful," he says. "There's no room for it to go higher."
Gladys and Robert Edmonds believe they should be offered a lifeline as well. The retirees in Tiverton, R.I., aren't eligible for government help because they don't have a subprime loan. Instead, the Edmondses, who live on a fixed income, say they refinanced their home in 2005 by taking out an option ARM, which lets borrowers pay small amounts early but that risks sharp payment increases later.
The couple has run up credit cards trying to keep current on their home payments, which have climbed from $1,480 to about $1,800 and will rise again to more than $2,000 in January. They say they were approached to refinance by a telephone solicitor and that the loan's terms weren't properly explained. "We're not the kind of people to neglect our debts," says Ms. Edmonds.
At its most basic level, the Bush-supported proposal is aimed at stopping and reversing the real-estate market's spreading turmoil. As foreclosures have increased, they have added to the number of houses for sale, depressing prices. Falling prices encourage more people to stop paying their mortgages and go into default, because their homes are worth less than their loans. More homes go into foreclosure.
The program aims to assist borrowers able to keep up with payments at their introductory rates but who will likely fall behind and face foreclosure if their rates go up as scheduled.
According to the plan, homeowners would contact credit counselors or their loan-servicing companies, who would sort them by their credit and payment history and ability to pay. Those 60 days behind on more than one mortgage payment over the past year would most likely receive no assistance, other than credit counseling to talk them through the loss of their homes. In the triage of the mortgage industry, they are considered largely beyond help.
"If the sheriff is at your door hauling out your furniture, and that's the first time you call your lenders, then you're probably too late," said Steve Bartlett, president of the Financial Services Roundtable, a trade association of the country's 100 largest banks, mortgage servicers, insurance companies and mutual-fund companies. Treasury Secretary Henry Paulson asked the group to coordinate the industry negotiations, in a forum called the Hope Now Alliance.
The alliance estimates that 600,000 of the subprime borrowers whose rates will reset in the next two years fall into this category. They are likely to lose their homes, or, in Mr. Paulson's words, "become renters."
The 1.2 million borrowers relatively current in their mortgages will be considered for the government-endorsed program. They will pass through the next set of screening to determine whether they can refinance at more-favorable mortgage rates. Some 600,000 borrowers are expected to qualify. These borrowers are expected to be offered counseling and a fast track to secure refinanced mortgages.
The remaining 600,000 won't qualify to refinance their existing mortgage, the alliance estimates. Such borrowers' loan servicers or counselors would determine whether they can afford to pay the higher interest rates once their introductory rates expire. The servicers will assume that those with better credit scores and more equity can afford to pay when their existing loans adjust upward. They would receive no special assistance.
Those who can't afford the higher payments, and who have credit scores below 660 and less than 3% equity in their homes, will get the biggest break from the lenders. They receive a five-year extension on their introductory interest rates, with the possibility that the grace period will be extended. Such a rate freeze would be available only to people who live in the mortgaged properties.
A middle group, who may or may not struggle with the increased interest rates, will have to negotiate individually with their loan-servicing companies to secure a rate freeze, repayment holiday or other relief.
Mortgage-industry officials say they aren't sure how many subprime borrowers will ultimately see their rates frozen.
Mr. Bush, speaking in front of a White House fireplace mantel festooned with greenery and gold ornaments, sought mainly to calm homeowners. "The holidays are fast approaching, and unfortunately, this will be a time of anxiety for Americans worried about their mortgages and their homes," he said.
He said the initiative was focused squarely on borrowers, not on investors. "We should not bail out lenders, real-estate speculators or those who made the reckless decision to buy a home they knew they could never afford," Mr. Bush said. "Yet there are some responsible homeowners who could avoid foreclosure with some assistance."
Treasury Secretary Paulson addressed some of the criticism about the plan's scope. "The approach announced today is not a silver bullet," he told reporters yesterday. "We face a difficult problem for which there is no perfect solution."
The program will be closely watched in markets around the world, where subprime defaults have triggered steep write-downs and constrictions in credit markets. Many banks and investment funds invested in complex securities backed by subprime mortgages, which promised high returns but are now battered and difficult to value.
The rescue package suggests that most investors prefer to give up some interest revenue rather than carry out expensive foreclosures of thousands of homes. But the plan won't reduce their losses by much. Analysts at Barclays Capital Research said in a report that the Treasury's plan could reduce cumulative losses from subprime loans by 0.6 to 1 percentage point, "which is not much relief when losses could reach 13% to 15%."
Investors who hold mortgages, meanwhile, would still bear the risk of the loans under the plan, said Doug Dachille, chief executive of First Principles Capital Management in New York, which invests in some mortgage-backed securities. Creditors would also bear the pain of forgone income from mortgages that under normal market conditions would have brought higher interest income.
"There ought to be costs to both the borrowers and lenders, but right now you're just giving a freebie to homeowners," he says. "They still get to live in their house and benefit from any appreciation in the value of the house over the next few years."
Milton Ezrati, market strategist with money-management firm Lord Abbett & Co., says the plan could undermine the market for mortgage-backed securities. Investors may say, "if you can interrupt my cash flow today, you can do it tomorrow," says Mr. Ezrati.
Another question concerns mortgage servicers, the companies that collect payments on behalf of the eventual debt holder: Can they change the terms of mortgages without being sued by the investors who purchased them?
Jordan Schwartz, a structured-finance partner at law firm Cadwalader, Wickersham & Taft LLP, says agreements that govern mortgage securities generally give servicers discretion to modify loans if they consider it to be in the best interest of investors who hold the securities. But any plan that emerges from Washington "won't have the force of law," he says.
George P. Miller, executive director of the American Securitization Forum, a trade association of investors, servicers and other securitization players, said servicers won't receive a guarantee against being sued. But because the plan was created by major industry players, including his group, and was endorsed by the Treasury Department, it offers a substantial shield against lawsuits.
Alan Gulick, a spokesman for Washington Mutual Inc., Seattle, the sixth-largest subprime servicer, according to Inside Mortgage Finance, said the bank is "supportive of the proposal." Mike Heid, co-president of home mortgages at Wells Fargo & Co., the eighth-largest servicer, said his bank played a key role in developing the plan to help consumers who have managed their mortgages well but are "caught in the current whirlwind of market forces."
