Whom Will the Subprime Plan Help?

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Erin Siegal / Reuters

A foreclosure sign in Antioch, California.

Don't be fooled. The Bush Administration's deal with lenders to get them to freeze interest rates on some adjustable-rate subprime loans isn't really about rescuing lots of homeowners. It's mainly about buying some time for mortgage servicers, Wall Street firms and investors around the world who face a chaotic couple of years as foreclosures rise and a couple million subprime loans reset at higher rates.

Treasury Secretary Henry Paulson made that very clear Thursday afternoon. "This is a private sector initiative to deal with the volume of resets," Paulson said at a press conference following the unveiling of the plan. "You get approximately the same result as if you did it on a case-by-case basis."

Paulson was responding to criticism that the rate freeze is a bailout for the irresponsible — borrowers and lenders alike. "In the normal case this is how markets work," he said. "There are workouts, and there are modifications."

But the specialized nature of modern mortgage markets — in which banks and mortgage brokers make the loans, investors buy them, and servicers collect the monthly payments — can make workouts complicated, and right now the system is overwhelmed by the sheer number of loans running into trouble. A study by Moody's in September found that terms were being modified on only 1% of the subprime loans resetting to higher rates this year — and the Mortgage Bankers Association of America reported this morning that the percentage of all mortgage loans in foreclosure at the end of September was, at 1.69%, the highest since they started keeping track in 1972.

Of the mortgages that went into foreclosure in the third quarter, 43% were adjustable-rate subprime loans, even though those make up only 6.8% of all outstanding loans. It is precisely these subprime ARMs, most of which came with low "teaser" rates that later reset to much higher rates, that the Administration's rate freeze is aimed at. It calls for lenders to observe a five-year freeze on rates for mortgages due to reset between Jan. 1, 2008 and July 31, 2010. It's entirely voluntarily, but Paulson has lined up big mortgage servicers and investors behind it.

The big question is how many homeowners will actually be able to take advantage of the deal. In announcing it this afternoon, President Bush said "up to 1.2 million American homeowners ... could be eligible for this assistance." But it's likely the number able to meet the terms of the rate freeze — crucially, you have to have been making your payments, but be unable to keep doing so after the rate rise — will be much smaller than that. Earlier this week, reports The Wall Street Journal, the director of the Office of Thrift Supervision, John Reich, estimated that "tens of thousands" could be helped.

As Paulson himself acknowledged about the plan, it's "not a silver bullet." And there are lingering concerns that, while the freeze may calm roiled mortgage markets for a time, it may merely delay the inevitable bottoming out of real estate prices. "The sooner we face reality and be done with it the better off we are," said Alan Ziobrowski, a professor of real estate finance at Georgia State University, in a telephone interview. "To drag this out for four, five, six years is just not a help."