Last week’s announcement by President Bush and Treasury Secretary Paulson that the federal government would come to the rescue of 1.2 million homeowners who will potentially default on home loan payments over the next year created a storm of commentary. Here’s my two cents. The lawyer in me believes there is a constitutional law obstacle to this plan; namely, that the government cannot impair private contracts, which is, after all, what home loan notes and deeds of trust (commonly known as “mortgages”) are. Indeed, most of the mortgages in question are no longer owned by the people who made them, but by investors who purchased the home owners’ contracts to pay according to a set rate and time schedule. But the courts will adjudicate that. Assuming that it is held Constitutional, rates will be frozen for a very, very, very, very select group of folks. To qualify to have your rate frozen for 5 years you would have to meet ALL of the following criteria: - Live in the property as your primary residence (no flipping investors allowed)
- Have a start rate of "sub prime level", probably 7-8%
- Begin adjusting in 2008 or 2009 (so much for those who’ve already adjusted)
- No more than 60 days late on any mortgage payment
- Have a credit score lower than when your loan started
- Not be able to qualify for a loan at the rate to which you would adjust
Thus "A" borrowers need not apply. Nor fixed-rate borrowers. Nor chronic delinquents. Nor people who have improved their credit. Nor people who could qualify and "afford" the adjustments. Like any government program, this one is not simple. Last week’s radio talk shows and other media carried a lot of outrage over the fairness of this “bailout.” Indeed, it does seem unfair to help those folks who got into loan payment obligations that they couldn’t really afford and make the rest of us, who did the right thing, continue to struggle with payments or live in our less expensive homes. But the concern of the government here is not bailing out undeserving people, but protecting the rest of us from a snowballing economic recession. In the process, some slugs get bailed out, but it’s for the greater good, not for them.
Here’s the way today’s Wall Street Journal put the motivation for the Bush Administration plan:
"As house prices fall and homeowners default on mortgages at troubling rates, the pain has spread far and wide. An examination of the resulting crisis shows that it is comparable to some of the biggest financial disasters of the past half-century.
So far, the potential losses look manageable compared with the savings-and-loan crisis of the 1980s and the tech-stock crash of 2000-02. But the housing debacle could yet take years to work out, thanks to the sheer complexity of it. Until the mess is cleaned up, investors will remain jittery and banks will likely hold back on all kinds of lending -- a credit crunch that is already damping global growth and could tip the U.S. economy into recession."
So, this plan is not a social welfare program for dead-beat borrowers, it’s a macroeconomic response to a market problem that could hurt all of us if it is not handled properly. The question is, how best to handle it. The people who now own the mortgage-backed securities have a strong motivation to re-negotiate with borrowers who may be in default soon, or those who already are. After all, they are money managers, not property managers. If they can keep someone in a home at a reasonable payment, even if less than originally agreed to, it may be better for their investment than owning a vacant property in a market glutted with homes for sale. The problem, according to U.S. Treasury Secretary Paulson, is that there are so many. He was on the track of “encouraging” the mortgage-service industry to take group approach to renegotiations two weeks ago. Apparently, that was not moving along fast enough, in the judgment of the administration, to keep pace with events in the economy. |
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