Will lenders freeze ARMs?

Good morning. A while back we posted on a speech in which the head of the FDIC encouraged lenders to freeze adjustable rate mortgages so that homebuyers won't have to worry about higher payments. That idea lives on: The New York Times editorial page, which we consider to be as influential as any left-of-center institution in America, this weekend strongly endorsed the little-noticed FDIC proposal:

After arguing the economy needs to be "rescued" from the mortgage crisis, the Times writes, "Fortunately, the Federal Deposit Insurance Corporation has come up with such a solution. It has made a compelling case for freezing the introductory rates, typically 7 percent or 8 percent, on the most default-prone adjustable-rate loans. To qualify, a borrower would need to live in the home, be current in monthly payments and not yet have faced an increase in the loan’s rate. The plan would remove up to 1.75 million people from the ranks of future defaulters."

The idea raises numerous questions, which we've posed before -- not the least of which is fairness. Why should lenders cut a break to borrowers who chose a risky mortgage? Leaving aside that question, we thought the Times editorial was newsworthy: The N.Y. Times is a "thought leader," particularly within the Democratic Party, which could soon control the White House and both houses of Congress.

Thoughts? Comments? E-mail story tips to lalandblog@yahoo.com.

Comments

[MBwatcher]

And how long are the rates frozen?

What if rates decline?

And don't forget, it's the end of the interest-only period (the "recast" to an amortizing payment, as opposed to the "reset" of the rate) that causes just as big, maybe a bigger, payment shock. See:

http://mbcon.blogspot.com/2007/08/
more-info-on-arm-resets.html

You can't hold a note for 30 years without paying principal. Well, you can, but that's also called renting.

[Paul Hiller]

This seems like a classic case of misdiagnosis of the problem. The real problem the borrowers are facing is asset deflation. The bulk of the current crop of distressed debtors, are people who bought or refied in late 04 through early 05. Most would have problem sustaining the debt even at a frozen rate over the long haul. Many were counting on the miracle of continually rising prices to keep them solvent. There is a saying in the biz that if the asset is inflating, then people will crush cans to make the payment. When it's not, well, they lose some enthusiasm. The really scary part is that this wave of defaults will barely get our feet wet compared to the huge wave that's on the way. While I have some very real libertarian tendencies, I also believe that there will be a lot of suffering, and some very good hard working people will be displaced. I guess my biggest fear is that I don't think the government can put a dent in the problem without breaking all of us, and I don't think they will be able to surgically hone in to really help the most deserving.

[ButlerS]

Fair? who told you life was fair?

Why should lenders cut a break to borrowers who chose a risky mortgage?

Lenders don't want to lose money. Borrowers in default are a losing proposition for the lenders. They would rather they pay their monthly mortgage than deal with the time and expense of foreclosure. This is why the lenders might just freeze the rates. The lenders don't care if it is fair as long as they are making their money.

[MBwatcher]

More of those questions:

How long is the rate to be "frozen?" What if the applicable rate drops -- no benefit to the consumer, then?

Let's not forget that an equally big problem is "recasts" of loans from interest-only to fully amortizing. That's often as big of a source of payment shock as a rate reset (neg-am teaser rates excepted). See:

http://mbcon.blogspot.com/2007/08/
more-info-on-arm-resets.html

You can't convert the loan to a 30-year interest only. That's called paying rent.

[Toby]

That would cost Lenders Billions of dollars.

In fact they would probably lose twice as much money doing that (basically giving out free money for 30 years) than it would cost them to REO the property and then sell it for way less but creating a "Prime" higher interest mortgage.

Forget house pricing, Lenders live or die on interests on mortgages.

So they simply just can't do it.

Now as for the "if the Government takes over the loans and then freezes the interest rates", I believe, if they did this, the people that benefit from this should have to forgo any Social Security benefits in the future. That they still get taxed for it, but THIS would be them cashing out early.

I could live with that. In fact, if that was offered today, I would think long and hard about that option (a super low interest mortgage instead of a super low income monthly check).

Long and hard....

[Giacomo]

Everyone should be prepared to honor the terms of a contract they have signed.

The lenders have an obligation to their shareholders to seek the best return on investment; if that means giving borrowers some extra slack rather than going through foreclosure, so be it, but governmental agencies should not dictate it.

Beware of setting a precedent that debts will be forgiven, though; you'll be encouraging more reckless borrowing in the future.

[Hula Girl]

No! No! and Extra No. Unless my scumbag sub prime lender (read Countrywide), is willing to reward my stellar credit, 25% down payment, and 5.675% conforming interest with punctual payments by rolling back MY interest and payments to the same fixed intro rate as these over extended borrowers. I'm so tired of hearing how these poor borrowers didn't understand what they were signing. Well, damnit - they shouldn't have signed and now expect everyone to bail them out. Will the lenders take a hit by doing this? Hell, no! The taxpayers will take the hit as well as future "prime" borrowers.

Bad plan - give children health care first.

[Brian]

A problem with this proposal is that the majority of loan servicers are not the owners of the debt, the owners are investors in mortgage backed securities, CDOs or the like. The loan servicing agreement limits what modifications can be done to the loan. The loans were originally sold as high interest -- if the initial teaser rate is frozen, the securities pay less, are worth less, and will plummet in value. Is Sheila Bair then going to propose something to bail them out?

I expect there will be litigation if the terms of the securities are unilaterally changed by government fiat.

I hate to be hardhearted about this, but a large percentage of mortgages taken out in the in the 2004-2006 timeframe or cash out refinancings. Does the New York Times really think those people should be rewarded for their prolifigate spending?

What does that say to the rest of us suckers, who bought a house we could afford, with the down payment we saved for, and have continued to make the payments to which we legally contracted?

[joeinlosangeles]

--The idea raises numerous questions, which we've posed before -- not the least of which is fairness. Why should lenders cut a break to borrowers who chose a risky mortgage?--

The biggest issue is making the business case of why it's in the lenders self-interest to voluntarily take part in such a proposal. Ask the shareholders of countrywide and the other lenders if they want to lose money by voluntarily taking part in this program in order to nail out borrowers who took on risky loans and now can't pay. And that's the problem with people calling for the govt. or business to bail people out -- they never address who is going to pick up the tab (and someone has to) and why they should.

[Cal]

The main reason why I dont think this will happen, the bondholders are just more likely to sell off the problem and be done with it. The buyers of the loans will be basing the decision on the collateral value and not the borrower (since there are a lot of bad borrowers out there and sorting the wheat from the chaff would be difficult en masse).

Not saying it, Not saying it couldnt. But typically when investors get a hot potato they dont try and hold onto it until it cools down.

[Matt Walker]

This is all getting disgusting. Look, I would like to have a home, but when I went to look, I realized that I could not afford one. I did the right thing. Now, these people who just bought without thought. So who is really being punished: people like me who did the responsible and prudent thing? Why is the government not looking out for people like me. Instead, it seems like they will bail out these people and effectively freeze people like me out of the market.

[sunsetbeachguy]

LAW OF UNINTENDED CONSEQUENCES!

If the gov't actually rolls back interest rates for the imprudent and punishes lenders unilaterally.

All other mortgage based interest rates will SKYROCKET to pay for the bailout.

If this is adopted it will only accelerate and deepen the plunge in RE prices.

[EC]

Heh heh -- I have a 4.6% due to reset next September (to 1 yr. Treasuries, not LIBOR) and I'd be delighted to have it frozen for a few more years. Where do I sign up?

[Steve]

This is going to play out, watch. Behind the scenes the Goverment is putting a huge amount pressure on lenders to stop these resets. At this point I would estimate that the Feds will give the lenders a choice either act on this and they will force the lenders to take action to lock in low ARM rates for a period of time. You can see it coming. They will probalbly give Mozillo a choice jail or start locking up ARMs

[Ann]

Can't find the story but a few days ago, I read that a lot of the very large investors (the ones holding pieces of these sliced and diced into bits mortgage securtieis) have reinsurance against excessive losses from defaults.

Works that Lender makes loan. Loan is sold off to a fund which packages batches of mortgages and sells them as securities to foriegn banks, other funds etc. Some of the buyers (now owners of the loan) have insured the securities against losses from defaulting borrowers.

That means that the owner of the loan would actually be better off if the borrower defaulted (a loss under the reinsurance). In that case, the insurer makes up the difference of the lost profit after the sale of the property..

If the owners of the loan (whoever that maybe out a several billion people) agrees to modify the interest rate, their lost profit is their problem and they can not make a claim under the reinsurance.

Not sure if this is true, generally true or only a few of the large players holding these loans (and that is typically not the lender who wrote the check.)

Anybody have more information on this?

[Jeremy R]

"they will force the lenders to take action to lock in low ARM rates for a period of time"

A triple dog dare the government to do this. I want the government to try and stop the power of the free market. I really hope they do. I will trade all my money for Euros and then invest those euros into international Bonds. After a 10 year period of our country paying the consequences for this dumb policy, I will buy a house in LA for 100,000 euros.