Monday, December 3, 2007

Mortgage Interest Rate Freeze Proposal

The federal government and a number of mortgage lenders are working on a temporary freeze of interest rates on some adjustable rate mortgages. In other words, monthly payments would remain where they are today for longer than the mortgage provides. Although the details aren’t clear yet, some general outlines of the proposal have emerged. For eligible borrowers, the mortgage interest rate would remain at its initial level for at least a few years. Since the initial rate is often a “teaser” rate that doesn’t reflect the full cost to lenders of making the loan, a rate freeze means losses for lenders and gains for borrowers.

The discussions about the mortgage rate freeze have reportedly separated borrowers into three categories: those that can pay their adjustable rate loans even if the monthly payment is hiked, those that cannot pay the adjustable rate loans even if the rate is frozen, and those that need the rate freeze to stay in their homes. Only those persons in the last category, whose need is clear and who are likely to benefit, are under serious consideration for a rate freeze. Borrowers who took out “no doc” loans (i.e., without documenting their income and assets) would reportedly not be eligible for a rate freeze.

The idea behind the rate freeze is evidently to prevent a meltdown in real estate values. When a large number of homes go into foreclosure, neighborhoods are filled with vacant homes for sale, which may be sold at distress prices. This reduces the values of the remaining homes in the neighborhood and hampers additional homeowners that need to refinance or sell. Home values can spiral downwards, which creates more defaults and foreclosures that worsen price declines. Everyone—homeowners, banks and other lenders, and mortgage investors—could be losers in such a scenario. A rate freeze on some adjustable rate mortgages would reduce the numbers of homeowners that default and ease some of the downward pressure on real estate prices.

The rate freeze would reportedly last for about three or four years. A short freeze, such as one year, would do little good, and a longer freeze would apparently be unacceptable to the investors that hold many of the mortgages in question. That gets to the crux of the rate freeze.

The mortgage rate freeze isn’t a bailout so much as a shifting of losses. Borrowers who would otherwise lose their homes get to stay in them, at least for now. Losses they might have sustained in a foreclosure are borne by lenders, or by investors if the mortgages were sold. Given the huge quantities of dumb mortgages that were written in the last few years, these losses are large and were inevitable. The only question is where they would land.

Assuming the rate freeze is implemented, losses will shift to banks and mortgage investors. That won’t necessarily be the end of the story. Many large banks are already staggering under losses from CDOs, SIVs, lbo loan commitments, and other fallout from the subprime mess and the credit crunch. Losses from a temporary mortgage rate freeze will only make things worse for them. Will they need a bailout from the taxpayers? One hopes not, but the banks and their lobbyists are probably working day and night to find some way to foist the costs of these problems (including those from a mortgage interest rate freeze) onto the Chevy Cavalier-driving, standard deduction-taking middle class folks who make up the backbone of the work force.

Some mortgage investors—such as millionaires who own interests in hedge funds—can afford to bear the losses from a rate freeze. Other mortgage investors—say, municipalities in northern Norway or the Intermountain West of the U.S.—are much less able to bear these losses. The rate freeze may not be the end of the story, since investors can hire lawyers and sue the banks that sold them mortgage-backed investments.

Another probable goal of the temporary rate freeze would be to prop up Fannie Mae and Freddie Mac. These two companies, which serve as key players in the secondary mortgage market, are booking big losses as it is. A downward spiral of real estate values could push them into insolvency. Après ça, le déluge.

The temporary term of the rate freeze—perhaps three or four years—pushes many mortgage payment increases into the next president’s term. Things could really blow up then if interest rates haven’t decreased or if real estate values remain low. Both could happen. The specter of inflation—fueled by the declining dollar and high petroleum prices--hovers above us in Damoclean fashion and could prevent interest rates from falling much more. The real estate markets will probably need a number of years to recover from their current doldrums. (See for a discussion of why the real estate markets will be limping for years.) The temporary rate freeze is another example of the government winging it as a crisis unfolds. Let’s hope these people leave us in better shape than they left New Orleans.

Legal News: jailbirds ignore food police.

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