m-o-r-a-l h-a-z-a-r-d

[fishpoopoo]

man, these guys nailed it on the head.

GLOBAL INTELLIGENCE BRIEF
12.06.2007

U.S.: Bush's Mortgage Bailout Plan
Summary

The U.S. administration has announced the launch of a bailout program to address the subprime mortgage crisis. The populist plan will settle the problem for now but will leave a land mine for the next president.

Analysis

The George W. Bush administration announced a bailout program Dec. 6 to address the crisis in the subprime mortgage market.

Subprime mortgages are those granted to people with either questionable or insufficient credit history. These loans typically have higher interest rates -- and therefore require larger payments -- to compensate for the higher risks that financial institutions take when granting such loans. The subprime crisis originated because mortgage brokers, in order to increase their income, began eroding the criteria used to evaluate potential homebuyers. Their income is based on the number of loans granted, not the quality of the loans. The result was a surge in activity in the subprime market, as people who lacked the financial ability to pay a mortgage were awarded loans.

The worst activity that the mortgage companies engaged in was something called teaser rates: granting new buyers a reduced interest rate on their loans for a short period, and then jacking up the rates to reflect the true risk of the loan later on. Higher rates mean higher payments, and for people with questionable credit this essentially meant that their homes would be taken away from them when the rates reset.

This resetting is the target of the Bush plan. In essence, the plan is to freeze those mortgages at the teaser rate for an additional five years. There are conditions, however.

First, the freeze will apply only to mortgages issued between January 2005 and July 2007 -- at the height of the subprime surge -- and that are scheduled to be reset between January 2008 and July 2010. The intent is only to shave off the worst of the abuse and not rejigger the entire system. That responsibility falls on the financial institutions that are responsible for rating the risk on these mortgages (most of this has already been done).

Second, the homeowners must prove that they can handle their current payments -- specifically, that they have not been more than 60 days behind in the past 12 months and are no more than 30 days behind when they apply -- as well as that they cannot afford the payments that would be charged after the rates reset. The idea here is to assist only those who have taken out their mortgage in good faith, as well as to prevent those who do have the financial wherewithal from taking advantage of the assistance program. For most affected, these will be easy criteria to meet (assuming they have not already been foreclosed upon). Adjustable-rate subprime mortgages usually begin with 7 percent to 9 percent rates that later are reset to between 11 percent and 13 percent -- that translates into roughly a 50 percent increase in monthly payments, an increase far beyond most who already are skating the financial edge.

Finally, borrowers cannot hold more than 3 percent equity in their homes. This condition eliminates anyone who put a down payment on their home, focusing the entirety of the bailout on those people who financed 100 percent of the home's value.

All in all, the plan aims to help those for whom the assistance would actually provide a fighting chance (although in the long run the homeowners would still need to suss out a way to meet the higher payments themselves once the extension ends). Those who could not afford even the teaser rates, or those who can afford the reset rates do not qualify. That means this bailout will only help about one-quarter of the subprime borrowers from the chosen time frame. The other three-quarters are either not in danger, or are beyond help.

There are three implications of this plan. First, it is likely to do what it intends and "solve" the subprime crisis for now. It appears the plan will help roughly one-quarter of those affected -- the quarter that is most likely to move up the country's socio-economic ladder, assuming that they can get some help. The plan will -- at least for the five-year duration -- help put a floor under the housing market and mitigate the direct economic fallout from this specific crisis.

Second, and far less optimistically, the plan potentially damages the integrity of the U.S. housing industry. The U.S. mortgage market is the largest pool of money in the world, not just because Americans are affluent, but also because of the sanctity of both property rights and contracts. While it is difficult to speak on specifics before the plan is formally released, this bailout appears to tinker with the latter. If this proves to be just a one-off, little harm will be done. But if this sets a precedent that other presidents follow, then financial institutions will be forced to add a layer of political risk insurance to future mortgages. That would raise the cost of loans for everyone and retard economic growth on a national scale.

Those unlucky enough to hold the mortgages that qualify also will suffer an economic hit immediately, given that they were expecting additional payments from the mortgages when the rates reset. (The mortgages they hold will be worth less, both now and in the future).

The final implication is political. Say what you will about the merits or failings of this plan, its implementation removes subprime from the list of hot-button electoral issues for the time being. In fact, presidential would-be candidates Hillary Clinton and John Edwards independently prescribed remedies very similar to the Bush plan last week.

But the issue has not disappeared. Should those homeowners who qualify not substantially improve their economic well-being before the five-year extension wears out, then the seeds for a fresh subprime crisis beginning in January 2013 will have been sown.

That would make it a hot-button issue when the next U.S. president is attempting to run for re-election.

[Backbeach Jake]

This is nothing new in the Bush administration. Ride the high horse, leave the stable for the next guy to muck out. One defered disaster after another.

[eastendlu]

Just surfing down the proverbial slippery slope.

[striperman36]

Agree with all, nothing new here. The problem was letting it happen in the first place.

[EarnedStripes44]

...all of the above