Les Jones

Mortgage Crisis > Henry Paulson's Plan to Avert a Mortgage Collapse

There's been a lot of talk about the Bush administration's plan to forestall problems with adjustable rate mortgage resetting. Some blog posts have hinted that Bush planned to use taxpayer money to bail out homeowners or mortgage lenders, but there's been no definite work on that, or much information on the plan until now.

It turns out taxpayer money is not involved in the plan. From The New Yorker:

The Paulson plan is meant to buy borrowers—and, arguably, the economy—some time, by postponing the interest-rate resets for five years.

Not for everyone, though. The plan sets up a system of triage, separating borrowers into three categories: those who will be able to keep paying after the rates reset, or else refinance their loans; those who can pay now but won’t be able to when the rates go higher; and those for whom even the current rates are too high. Only the second group will get help. Also, the plan doesn’t go into effect until next year—if your loan resets on December 31st, you’re out of luck.

In theory, this solution is one that lenders could have arrived at on their own. Lenders often lose less money on a renegotiated loan than on a foreclosure, so they should be well equipped to triage bad loans, separating the workable from the truly hopeless cases. So why did the government need to get involved? One reason is that so many loans are going bad that the companies servicing them don’t have the people or the skills to evaluate them on a case-by-case basis. (A recent study found, for instance, that mortgage servicers renegotiated only one per cent of loans that reset in the first part of this year.) And, because most of these loans have been packaged into securities and sold to outside investors, the process of renegotiating mortgages is now far more complicated than just talking to the loan officer at your local bank. Paulson’s plan streamlines and simplifies the process by creating rough-and-ready definitions of creditworthiness. The Treasury Department’s sponsorship also permits a degree of collusion that might normally be considered illegal—banks aren’t typically allowed to work together to set loan prices. And it reduces, although it certainly doesn’t eliminate, the risk that the investors who actually own these mortgages will sue to prevent the wholesale renegotiation of the loans they own. It’s a powerful example of the way government can shape markets without ever passing a law or a new regulation.

Unfortunately, it’s also an example of the limits of such intervention. Although the plan will provide real relief for at least some homeowners, it’s more like a Band-Aid than like the major surgery that some of the hype makes out. That’s because at this point interest-rate resets are just a small part of the mortgage-market problem.