Help May Be on the Way
Passing squall or supersized economic blowout? However the housing and credit-market upheavals play out, they will shape the legacy of Treasury Secretary Henry M. Paulson Jr. From the start, he has tried to orchestrate a private-sector-led response to the wave of home loan defaults and price declines under way. But progress has been glacial.
Yet a comprehensive program may be within reach. It would get mortgage lenders, servicers, and investors to help eligible homeowners to renegotiate adjustable-rate mortgages (ARMs) that will reset and become far more expensive. "Well before the end of the year, we will have a template—and the infrastructure in place to make it easier to handle the wave [of resets] that is coming at us," he said in an interview with BusinessWeek.
"Focusing on the Middle"
The problem so far: Refinancing relief has largely been on a case-by-case basis, and the industry has been unable to agree on broad-based criteria that would allow it to quickly evaluate large pools of homeowners based on their financial standing. As things stand now, mortgage servicers have adjusted just 1% of the subprime loans on which rates reset in the first half of 2007, according to Moody's Investors Service (MCO).
Given the scale of the crisis, and the complexity of the ownership of securitized mortgages, only a sweeping plan involving all the industry players is likely to prevent a wave of foreclosures. Paulson, who was scheduled to meet mortgage leaders on Nov. 29, argues that a deal could go a long way toward easing pressures. He says the talks, which involve servicers and investors covering 85% of the market, will give rise to a far speedier and standardized method both for processing such workouts and determining who might be eligible.
Those who can readily pay after their resets won't qualify, of course. Yet neither will those who don't have the financial means to own a home even after refinancing. "We're focusing on the middle bucket," says Paulson. "We'll have broad agreement on criteria that will make it easier to modify mortgages in the volumes we need."
Some sort of breakthrough would be welcome. With market conditions deteriorating and Wall Street fearful that recession risks are rising, critics are asking whether the Administration needs to get far more aggressive in its approach. The U.S. stock market has been in manic-depressive mode for weeks on recession worries, and credit conditions have tightened.
Next year, without a better mechanism for home loan workouts, the mortgage industry turmoil could enter a dangerous new phase. Through September, roughly $45 billion in subprime ARMs were reset each quarter this year, according to Banc of America Securities (BAC). Starting in December, and through all of next year, that will jump to an average of $90 billion a quarter.
Paulson's efforts, if successful, would build on a similar push by Sheila C. Bair, head of the Federal Deposit Insurance Corp. In late October, she argued that mortgage servicers and lenders should simply freeze interest rates on resetting ARMs at the initial teaser rate, often around 7% to 9%. That's already above the mortgage rates borrowers with good credit pay. To qualify, borrowers would have to live in the homes—speculators need not apply—and be current on their payments.
So far, she has found one taker: On Nov. 20, California Governor Arnold Schwarzenegger announced a deal with four of the largest mortgage lenders in the state to streamline the loan-workout process and extend for at least several years the initial mortgage rates for struggling subprime borrowers. With some 500,000 loans scheduled to reset in the state over the next two years, California officials say the changes could help some 100,000 homeowners.
A Housing Market Emergency
Some complain the feds haven't done as much as they could. Yale University economist Robert J. Shiller and Clinton-era Treasury Secretary Lawrence H. Summers, who both warn that the U.S. housing market could face price declines of 25% to 30% in the next several years, have recently criticized what they see as a too-timid response to the crisis. Shiller says: "When someone's in the emergency room, you've got to give them care right away."
Shiller thinks personal bankruptcy laws should be modified to make it easier for troubled borrowers to stay in their homes. Summers argues that more is needed to keep money flowing to creditworthy home buyers, using the Federal Housing Administration, Freddie Mac (FRE), and Fannie Mae (FNM)—huge government-chartered entities that buy mortgages and package them into securities. He suggests that the government may even need to provide loans directly, or extend tax breaks to stretched families.
Paulson says his team is anything but timid. "We are examining all public policy ideas," he says. "We are being aggressive, and our thinking continues to evolve as we learn more."
Shiller and others believe more could be done through the FHA. Already, the Bush Administration has backed a program to let the agency expand its loan guarantees to some subprime buyers able to refinance their loans. But Alex J. Pollock, formerly head of the Federal Home Loan Bank of Chicago and now at the conservative American Enterprise Institute (AEI), says the FHA could take on a larger role in helping to ease pressures on subprime buyers whose homes are now worth less than their mortgages.
Pollock argues that the FHA should insure the refinancing of such mortgages at more realistic new prices, with Fannie or Freddie then buying the new loans from the mortgage lender. "What you want is a place where the borrower comes out ahead based on the current value of the home, and the lender comes out ahead compared with foreclosure," he says. This will "prevent the bust from going into a self-reinforcing downward cycle."
A severe housing bust is a scenario unacceptable to Paulson and the Bush Administration, though there is deep aversion among some free-market purists for anything that smells like a bailout. "This is what happens when people make imprudent decisions," says Peter J. Wallison, a Reagan-era Treasury official now at the AEI. He doesn't think the government can do much more to head off a housing-led recession than continue to cut interest rates. But in the face of worsening economic conditions, that is a view Paulson doesn't embrace.