Bush, Banks Unveil Plan to Stem Foreclosure Flood

Dec. 6, 2007 — -- Another shocking headline came out of the housing sector today: Delinquent payments on mortgages are now at the highest level since 1986, and some economists are calling this the most severe housing recession in the post-World War II period.

In response to worries about housing, President Bush and Treasury Secretary Henry Paulson announced a plan today that they hope will stop the flood of foreclosures.

The target is the estimated 1.2 million people who can afford their mortgages at the current rate, but not at the higher interest rate that their adjustable-rate loans are about to reset to.

But not everybody will fall into this rescue push.

"We should not bail out lenders, real estate speculators or those who made the reckless decision to buy a home they knew they could never afford," Bush said.

"There is no perfect solution," the president added. "The homeowners deserve our help. The steps I've outlined today are a sensible response to a serious challenge."

Credit Score Is Key

Banking executives for weeks have talked with government officials on a set of standards to deal with the growing problem.

Some homeowners with better credit would be able to refinance their loans in new fixed-rate mortgages with some lenders possibly waiving prepayment penalties.

Others would have their introductory "teaser" rates frozen for up to five years. Those homeowners would essentially need to have a credit score of 660 or less. And the homes would need to be owner-occupied.

The third group Bush spoke of, those who simply can't afford their homes, will still likely lose them. Basically the government and banks are saying: you probably should be renting.

The plan includes loans that were issued between Jan. 1, 2005 and July 31 of this year and have their rate reset sometime between Jan. 1, 2008 and July 31, 2010.

While this plan is aimed at those with the riskiest credit histories, the so-called subprime borrowers, its impact is expected to ripple throughout the entire economy.

"All homeowners will benefit from mortgage relief because it will keep the value of their homes from falling," said Peter Morici, an economist and business professor at the University of Maryland.

As more homes fall into foreclosure, the housing market gets flooded and prices start to fall. Morici said that historically, homes in foreclosure sell at a 20 percent discount.

"Right off the top we could see the value of homes fall by 20 [percent], 30 percent. It would likely fall further than that," he said.

So if Bush's push to slow that foreclosure flood is successful, home prices will start to stabilize, Morici said.

"This action will directly support the value of people's homes and it will more broadly prop up the value of the economy," he added.

Robert James Shiller, an economics professor at Yale University, said action was needed.

"We have a housing crisis that is looking to be the biggest since the Great Depression," he said. "A huge mortgage crisis then tends to bleed into everything."

No Bailout for Some

Shiller said that many of these homeowners should never have been given loans in the first place.

"I think the magnitude of the problem is going to continue to surprise us," he added.

An estimated 1.8 million subprime mortgages are about to reset in the next two years from their introductory rates of around 7 percent to levels as high as 11 percent, adding hundreds of dollars to the typical monthly payment.

This plan is expected to help about 1.2 million of those homeowners. The rest of the homeowners are either expected to be able to pay the higher rates or are deemed unable to make their mortgage payments no matter the rate. These are the people who shouldn't have been given a loan in the first place, according to Steve Bartlett, president and CEO of the Financial Services Roundtable, which negotiated with the Bush administration on behalf of the country's major banks and lenders.

"This is focused on the 2 million homeowners in the subprime market whose rates are about to reset who are the most at risk," Bartlett said. "That's a lot, but it's not everything."

House Financial Services Committee chairman Barney Frank said he told Paulson today that he opposed the agreement's cutoff of borrowers with credit scores above 660 out of a possible 850.

"There are a couple of problems with it," the Massachusetts Democrat,said at a hearing today. He said it penalizes those who struggled to maintain good credit profiles.

Bartlett said the plan is a good compromise.

"We're getting criticized from the right who say we are doing too much and from the left for not doing enough. So I guess that means we are doing it just about right," he said. "This is not a bail out for anyone. These are mortgages that people are current on and can pay, but not at 11 percent."

The banks — and the investors who subsequently bought the mortgages — are going to lose out on some money because they are getting a lower interest rate on their loaned capital. However, the losses from a continued and sustained wave of foreclosures could be a lot worse.

"Foreclosure loses don't help anyone," Bartlett said. "It's in our best interest as lenders to modify these mortgages if we can keep somebody in their home and keep them paying the mortgage."

Paulson said the standard loan-by-loan evaluation process that is current industry practice would not be able to handle the volume of work that will be required. That's why the industry and government devised this streamlined approach to address this increased volume.

"The investors who own these loans recognize that foreclosure is costly, and that a workout plan or mortgage modification often brings them greater value than foreclosure," Paulson said.

Senate Banking Chairman Christopher Dodd, a Connecticut Democrat who is running for president, attacked the plan.

"It shuts out hundreds of thousands of borrowers who are either in, or shortly will be facing, default in 2007 because of the abusive exploding ARM loans they were sold. These homeowners are no less deserving of a helping hand," Dodd said in a statement. "There appears to be no effort by the Bush Administration to hold lenders and servicers accountable for the agreements they make, so we know who is living up to their commitments and who is not.'"