Paulson Subprime Fix Is Cheered by Democrats, Panned by Right

By John Brinsley and Alison Vekshin

Dec. 6 (Bloomberg) -- Treasury Secretary Henry Paulson's success in crafting agreement on a five-year fix of subprime mortgage rates owes a debt to an unlikely source: congressional Democrats.

Legislation pushed by House Financial Services Committee Chairman Barney Frank that would bypass lenders and investors, giving power to judges to rewrite loans, helped persuade banks and securities-industry lobbyists to sign on to Paulson's effort, mortgage-industry analysts said.

``The Democrats have given Paulson more leverage and room to maneuver than he otherwise would have had,'' said Howard Glaser, a former chief legal adviser to Housing Secretary Andrew Cuomo under President Bill Clinton who now heads Glaser Group, a consulting firm. Paulson could tell lenders and investors ``if you go my way, you have some control over the outcome'' he said.

While Democrats endorsed the Paulson's effort to stem a wave of foreclosures on adjustable-rate loans resetting higher, some conservatives blasted the administration for breaking its commitment to free markets.

Paulson holds a press conference at 1:45 p.m. today to discuss the details and President George W. Bush is also scheduled to speak in Washington.

People familiar with the agreement said yesterday that it covers a group of subprime borrowers who could afford starter rates on their mortgages but not the higher payments after they reset.

``The threat of Democratic legislation'' served to ``increase the pressure on the mortgage lenders to strike a deal,'' said Michael Barr, a former special assistant to Treasury Secretary Robert Rubin and now professor at University of Michigan law school.

Clinton Response

Democratic Senator Hillary Clinton of New York, a candidate for her party's presidential nomination, said yesterday that she was ``heartened'' by Paulson's efforts, while urging further steps.

``A loan modification plan is a good thing, especially if you use it to help people take advantage,'' Frank told reporters in Washington on Dec. 4, a day after Paulson outlined his efforts at a housing conference.

The Democratic response may also help Paulson should the agreement need legislative backing. Frank's committee holds a hearing today that will consider a proposal to offer a ``safe harbor from legal liability'' to mortgage servicers. Federal Deposit Insurance Corp. Chairman Sheila Bair and other regulators are scheduled to testify.

Most subprime mortgages were packed into bonds and sold to investors. Fixing loans at low starter rates may undermine the $7.1 trillion market in mortgage securities.

That threat spurred criticism from conservative lobbyists and some Republican legislators, who said the government shouldn't have facilitated rewriting mortgages.

`Gun on the Table'

``It's akin to sitting down with an arbiter who puts a gun on the table and says, I hope you see my point,'' said Derek Hunter, federal affairs manager at Americans For Tax Reform, which advocates low taxes and is headed by Grover Norquist. ``The government shouldn't be involved in this.''

Martin Feldstein, who served in Ronald Reagan's White House and currently heads the National Bureau of Economic Research in Cambridge, Massachusetts, said the deal may hurt foreign investment in U.S. securities.

``What are they going to think about investing in American securities in the future if the government can say, well, you thought these were the interest rates and the contract, but we're going to roll that back now and you'll just have to settle for less?,'' Feldstein said in an interview yesterday.

`Very Problematic'

``My biggest concern is that there are a lot of Americans who are making their mortgage payments, they are current, and the benefit won't go to them,'' Alabama Representative Spencer Bachus, the top Republican on the House Financial Services Committee, told reporters after meeting with Paulson yesterday. ``It's very problematic when the government starts dictating changes.''

Paulson on Nov. 29 brought in executives from Citigroup Inc., Wells Fargo & Co. and Washington Mutual Inc., along with securities-industry lobbyists and other regulators, to negotiate an agreement aimed at minimizing defaults on subprime mortgages. The effort began as the U.S. housing industry entered a third year of recession, threatening the six-year economic expansion.

Subprime loans were designed for borrowers with poor or patchy credit history, and in some cases were the product of ``lax'' lending standards, Federal Reserve officials have said. Adjustable-rate subprime mortgages usually began with a rate of 7 percent to 9 percent for two or three years, and then reset to between 11 percent and 13 percent, John Reich, director of the Office of Thrift Supervision, said in an interview Dec. 3.

Estimated Impact

Deutsche Bank AG economists estimated about 1.2 million mortgages may be affected by the deal, representing $258 billion. There was a total of $10.1 trillion of home mortgages as of June, Fed data show. The Paulson agreement ``may help on the margin,'' Deutsche Bank economists wrote in a report Dec. 4.

Democratic Representatives Paul Kanjorski of Pennsylvania, Carolyn Maloney of New York and two Republicans on Frank's committee wrote participants in Paulson's talks yesterday pledging steps ``legislative or otherwise'' to help meet the objectives.

``It is good the administration is finally stepping up with a plan that respects the magnitude of the problem,'' Democratic Senator Charles Schumer of New York said in a statement yesterday.

To contact the reporter on this story: John Brinsley in Washington at jbrinsley@bloomberg.net

Last Updated: December 6, 2007 00:12 EST

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