Treasury, Federal Reserve To Rescue Mortgage Lenders, Subprime Mortgage Borrowers
The turnaround on Wall Street last week coincided with two reversals in Washington.
First, Federal Reserve policymakers started talking like doves, making clear that interest-rate cuts are back on the table. Then the Treasury Department picked up its bully club, setting aside its concerns about a heavy-handed approach to aiding subprime mortgage borrowers at risk of defaulting on their mortgages.
Fed Chairman Ben Bernanke said Thursday night that the economic outlook has been “importantly affected over the past month by renewed turbulence in financial markets.”
While Bernanke said the Fed will be “exceptionally alert and flexible” in responding to incoming data, Treasury Secretary Henry Paulson has seen enough data to conclude that the housing market needs a stronger response from Washington.
Instead of encouraging lenders to provide forbearance to borrowers on a case-by-case basis, Paulson is now pushing the mortgage industry to provide broad-based relief. Treasury hosted a meeting with industry officials and financial regulators on Thursday, and reports said the details of an agreement could be announced by the end of the year.
Bank of America estimates that the introductory interest rates on $362 billion worth of subprime mortgages are scheduled to reset upward in 2008. The higher rate typically adds 30% to 40% to the monthly mortgage bill.
Treasury is working with industry on a “a standardized approach to reach more homeowners faster,” department spokeswoman Jennifer Zuccarelli told reporters.
The parties reportedly are discussing a plan to freeze loans at the introductory rate for a period of three to seven years, with industry supporting the shorter freeze.
California Governor Arnold Schwarzenegger recently announced a deal under which four top mortgage lenders would extend lower initial rates to Californians for five years.
Under discussions in Washington, relief would only be provided to homeowners who remained up to date on their payments but can’t afford the higher rate they will face. Homeowners whose property values have dropped below the value of the mortgage would not qualify.
While the mortgage industry would have to voluntarily sign on to and carry out any proposal, the emerging policy has the imprint of government intervention, says Alex Pollock, resident fellow at the American Enterprise Institute.
“When does jawboning turn into arm-twisting?” he asks.
But Pollock believes that intervention of this kind is “reasonable” to make sure a housing market that overshot to the upside doesn’t “get into a downward spiral.”
Because the mortgage industry has every interest in avoiding an unnecessary wave of foreclosures, Pollock believes lenders can preserve more of the value of their loans by granting some relief.
Wall Street appeared to reach a similar conclusion, bidding up financial stocks on Friday amid news of an emerging subprime bailout. Battered shares of mortgage provider Countrywide Financial CFC rose 16%, while government-backed mortgage buyers Freddie Mac FRE and Fannie Mae each gained 19%.
“We believe this is good news for our sector as a whole, but believe that Countrywide will be the prime beneficiary as the nation’s largest servicer and top originator,” analysts at Fox-Pitt, Kelton wrote in a research report.
Subprime-mortgage-related ABX indexes rallied Friday, halting a long downward slide.
While it’s relatively easy, if time consuming, to weigh the costs and benefits of modifying an individual loan, providing broad-based relief to borrowers is more complex. And because the loans have been broken up and sold to securitization investors, there are legal hurdles.
Senator Charles Schumer, D-N.Y., welcomed news of Treasury’s more aggressive approach, but also raised some doubts.
“This is the first time that the Bush administration is working towards a solution that meets the magnitude of the problem,” Schumer said. “But there is a $64,000 question: Will investors go along with this plan? And if not, can they be compelled to?”
New York University Professor Nouriel Roubini wrote that a mere 1% of subprime mortgages have been modified “as lenders and servicers did not have either the skills or the human resources or the physical resources.”
He argues that “while an across-the-board approach is not totally fair … this approach is the only feasible way to deal with the need to rapidly restructure millions of separate debt contracts.”
Adjustable Rate Mortgage - Monthly Mortgage Reset - 2007 to 2015