Bush Aims to Prolong Expansion With Subprime Freeze (Update6)

By Alison Vekshin

Dec. 6 (Bloomberg) -- President George W. Bush today announced a freeze on some subprime mortgage rates in an effort to stop a wave of foreclosures from undoing the six-year expansion.

Treasury Secretary Henry Paulson and regulators forged the agreement with lenders that will fix interest rates on some loans for five years. The deal is focused on borrowers who will fall behind once initially low rates reset to higher levels through July 2010.

``We face a difficult problem for which there is no perfect solution,'' Paulson said at a news conference in Washington. ``The current system for working out those problem loans would not be sufficient to handle the anticipated 1.8 million owner-occupied subprime mortgage resets that will occur in 2008 and 2009.''

The housing slump, now in its third year, is pushing home values down and restraining economic growth, which economists estimate will be less than 1 percent this quarter. The collapse in the market for securities backed by subprime mortgages cost the chief executive officers of Merrill Lynch & Co. and Citigroup Inc. their jobs, roiled markets from Auckland to New York and forced the Federal Reserve to cut interest rates twice.

``The magnitude of the economic impact on housing prices in the absence of this plan under current conditions is large,'' said Susan Wachter, professor of real estate at the University of Pennsylvania's Wharton School in Philadelphia.

Bush said in a statement at the White House, accompanied by Paulson and Housing and Urban Development Secretary Alphonso Jackson, that ``the housing market is moving through a period of change'' and foreclosures would hurt the economy.

Ways to Help

The agreement addresses homeowners unable to afford higher interest rates once starter rates increase, and offers help in one of three ways, a White House official said. The options are freezing rates or refinancing into either a new private mortgage or a Federal Housing Administration-backed loan, he said on condition of anonymity.

The measures may help more than 1 million subprime borrowers avoid foreclosure over the next two years, the official said.

Global stocks rose, led by financial companies. The MSCI World Index added 0.2 percent to 1,612.27 as of 10:43 a.m. in New York after reaching a four-week high earlier. The Standard & Poor's 500 Index also gained 0.2 percent.

More than 30 percent of borrowers with subprime adjustable- rate mortgages are behind on their payments before their loans reset at a higher rate, according to estimates from analysts at Credit Suisse Group. The bank projects 775,000 homes with $143 billion of mortgage debt will go into foreclosure in the next two years.

20-Year High

The number of Americans behind on their mortgage payments was the highest in 20 years in the third quarter, the Mortgage Bankers Association said today. The share of all home loans with payments more than 30 days late rose to a seasonally adjusted 5.59 percent, the MBA said.

``We know when foreclosures hit, it brings down the value of the neighborhood by 20 percent,'' said David Olson, president and co-founder of Wholesale Access Mortgage Research and Consulting Inc. in Columbia, Maryland. ```That's what they are trying to avoid.''

Officials and executives from companies including Citigroup, Wells Fargo & Co. and Washington Mutual Inc. spent much of the past week negotiating how long to extend starter rates on subprime mortgages, which are usually given to people with poor or incomplete credit histories.

The freeze will apply to mortgages issued between January 2005 and July 2007 that are scheduled to reset between January 2008 and July 2010, said people familiar with the plan.

To be eligible, borrowers must not be more than 60 days behind in their payments, have less than 3 percent equity in their property.

Frank's Reaction

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

``There are a couple of problems with it,'' Frank, a Massachusetts Democrat, said at a hearing on housing today. It's a ``grave error that there's a cutoff at a 660 FICO score,'' he said. That penalizes those who struggled to maintain good credit profiles, he said. Frank also faulted the plan for failing to address the penalty for prepaying many subprime mortgages.

Most U.S. banks use FICO credit scores, a product of Minneapolis-based Fair Isaac Corp., to judge a borrower's ability to repay loans. Scores are correlated to interest rates banks are willing to charge.

``I support what I know the administration is doing,'' House Speaker Nancy Pelosi of California said today.

`Something Drastic'

``We have got to do something drastic, and we have to do something quickly,'' said Representative Elton Gallegly, a Republican from California. ``I don't like the government getting involved in the private sector, but we have potential problems we are already seeing come to pass.''

Some Republicans expressed skepticism.

``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,'' Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, told reporters after a meeting with Paulson yesterday.

One challenge has been to craft a deal minimizing lawsuits from investors in bonds backed by the mortgages being rewritten, analysts said. The longer that lower rates are extended, the more risk posed to the bonds' values. Republican Representative Mike Castle of Delaware has proposed legislation offering a ``safe harbor from legal liability'' to mortgage servicers.

`Be Careful'

``The things that make the U.S. mortgage market the capital-market success that it is are property rights and the sanctity of contracts, so they have to be careful to not damage either one of those,'' said Scott Simon, head of mortgage- and asset-backed bond investing at Pacific Investment Management Co.

Simon, whose Newport Beach, California-based firm manages the world's largest bond fund, declined to comment on the plan itself until its details are announced.

Foreclosures almost doubled in October from a year earlier as subprime borrowers failed to make higher payments, Irvine, California-based RealtyTrac Inc. said Nov. 29.

Adjustable-rate subprime mortgages usually begin with 7 percent to 9 percent rates that reset to between 11 percent and 13 percent. ``What we are talking about is having these loans modified, so they continue for a longer period of time at the starter rate,'' John Reich, director of the Office of Thrift Supervision, said in an interview Dec. 3.

To contact the reporter on this story: Alison Vekshin in Washington at avekshin@bloomberg.net

Last Updated: December 6, 2007 13:58 EST

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