IE 11 is not supported. For an optimal experience visit our site on another browser.

Banks, U.S. near deal on subprime mortgages

The Bush administration is working with the mortgage industry on a plan to extend lower, introductory interest rates on home loans before they reset at higher levels.
/ Source: The Associated Press

The Bush administration and the mortgage industry, trying to combat a massive wave of foreclosures, are hammering out a proposal to temporarily freeze interest rates on certain troubled subprime mortgages. If adopted, it would be the biggest action taken to cope with the unfolding crisis.

The administration was still holding discussions on Friday, trying to work out details of the proposal, which could be unveiled as early as next week. Some indications of the outlines of the proposal may come in a speech Treasury Secretary Henry Paulson is scheduled to deliver to a national housing conference on Monday.

The talks have involved all the federal banking regulators and major players in the mortgage industry such as Citigroup Inc., Wells Fargo & Co. and Countrywide Financial Corp.

The major thrust of the proposal would be to get lenders to extend for a number of years the low, introductory rates that were offered on subprime mortgages, loans usually offered to borrowers with weak credit histories.

An estimated 2 million of those initial low, teaser rates are scheduled to reset to much higher levels by the end of next year, pushing the payment on a typical mortgage from $1,200 per month to $1,550, an increase of $350. The concern is that many homeowners will not be able to meet the higher payments, triggering hundreds of thousands of defaults.

That would dump even more unsold homes on an already glutted housing market, pushing home prices down further, jolting consumer confidence and raising the risks of a full-blown recession.

By offering a broad approach to extend the teaser rates for a certain period — officials and the industry are debating time periods of two to five years — it would allow between homeowners to keep making payments while the housing industry regains its footing.

Once the industry stabilizes and home prices are no longer falling, it will be easier for homeowners to refinance their adjustable rate loans to more favorable fixed-rate mortgages.

Asked about the proposal on Friday, presidential press secretary Dana Perino said, "The president has been clear that no taxpayer money should be used for any sort of bailout."

The plan under consideration does not include any government funds, but it would mean losses for investors who purchased mortgage-backed securities because they would be getting a lower income stream reflecting the delay in having the introductory interest rates reset. But it would still represent more money than if the mortgage went into default.

The rising tide of defaults on subprime mortgages in recent months has already forced a number of major financial institutions to declare multibillion-dollar losses, a development that seriously roiled financial markets not only in the United States but also in Europe over the summer.

Economists on Friday generally praised the administration's effort, saying it should help stave off a potential recession in this country.

"This is a significant problem that could overwhelm the economy unless policymakers take action," said Mark Zandi, chief economist at Moody's "The economy is already on the brink of a recession."

David Wyss, an economist at Standard & Poor's, said offering a blanket approach should prompt more people to seek help.

"People don't want to tell there banker that they can't pay," he said. "But if you tell people in advance that this is what we will be able to do for you, you will get more people going to the banks ahead of time so they can be helped."

A survey by Moody's Investors Service found that only about 1 percent of the loans that reset in January, April and July had been modified by mortgage service firms.

Edward Yardeni, head of Yardeni Research, quipped that the program should be given a catchy title such as the "Teaser Freezer."

Democrats who have been highly critical of the administration for moving too slowly to confront the mortgage crisis were generally supportive Friday of the new proposal.

"This is the first time that the Bush administration is working towards a solution that meets the magnitude of the problem," said Sen. Charles Schumer, D-N.Y. But he said "the $64,000 dollar question" will be if investors will go along with the proposal.

Rep. Rahm Emanuel, D-Ill., called the proposal "an important building block in our efforts to address the mortgage and credit crisis."

The administration is working through an industry coalition, dubbed Hope Now, to get the program launched. Elements of the program are expected to be modeled after an approach put forward several months ago by Sheila Bair, the head of the Federal Deposit Insurance Corp. Last week, California announced a similar effort involving four major loan servicing companies.

Bair's plan would apply only for borrowers who are current on mortgage payments but unable to afford loans that reset to higher rates. "We need to have long-term sustainable modifications," Bair said at a news conference this week.

Critics said companies could face lawsuits if they permit modifications that are not in the best interest of investors. Supporters, however, argue investors would stand to benefit because they would avoid the cost of a foreclosure — estimated to be around $50,000 per loan.