A Plan to Freeze Subprime Rates

Treasury Secretary Paulson is pushing a plan to freeze interest rates for some subprime borrowers:

U.S., Banks Near A Plan to Freeze Subprime Rates, by Deborah Solomon and Michael M. Phillips, WSJ: The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans...

An accord could reassure investors and strapped homeowners ... on more than two million adjustable mortgages are scheduled to jump over the next two years. ...

The plan is being negotiated between regulators including the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp. ...

Details of the plan, which could be announced as early as next week, are still being worked out. In general, the government and the coalition have largely agreed to extend the lower introductory rate on home loans for certain borrowers who will have trouble making payments once their mortgages increase.

Many subprime loans carry a low "teaser" interest rate for the first two or three years, then reset to a higher rate for the remainder of the term, which is typically 30 years in total. In a typical case, the rate would rise to around 9.5% to 11% from 7% or 8%. That would boost an average borrower's payment by several hundred dollars a month.

Exactly which borrowers will qualify for the freeze and how long the freeze would last are yet to be determined. ... The parties are developing standard criteria that would determine eligibility. The criteria should be finalized by the end of year. ...

The mortgage servicers in the coalition represent 84% of the overall subprime market. The coalition also includes lenders, investors and mortgage counselors. ...

While the government can't force the industry to modify loans, Mr. Paulson and other administration officials have been using moral suasion to push for workouts...

Among the holdouts have been investors, who typically hold securities backed by mortgages. If interest rates are frozen, they would lose the potential benefit of higher payments. But investors have cautiously moved toward cooperation, likely on the grounds that it's better to get some interest than none at all. ...

Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups: those who can continue to make their payments even if rates rise, those who can't afford their mortgages even if rates stay steady, and those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates. Only the third group would be eligible for help. The creditors are likely to look at whether the borrowers have equity in their homes, despite falling house prices, and whether their incomes are holding steady.

Mr. Paulson, who is philosophically opposed to federal meddling in markets, at first rejected a sweeping approach to loan modifications... But he shifted his position recently. He told The Wall Street Journal last week that it would be impossible to "process the number of workouts and modifications that are going to be necessary doing it just sort of one-off." ...

Officials in Washington have been cautious about steps that would be seen as rescuing borrowers, lenders and investors from the consequences of their own bad decisions. That is why few are suggesting direct support for borrowers who can't afford their loans. Mr. Paulson has decided his best option is to prod the markets to sort matters out themselves, as long as companies bear in mind the public interest in keeping people in their homes. ...

"If I ever saw a role for government, it is...to bring the private sector together when innovation has really outrun our ability to deal with it," Mr. Paulson said. ...

Will this be enough to make a difference?