"temporary" mortgage freeze is doomed

The Bush Administration is proposing a "temporary" freeze on interest rates in the latest misguided government intrusion into private business activity.

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, according to people familiar with the negotiations.

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. People familiar with the talks say the individual members have agreed to follow any agreement reached by the coalition, which is called the Hope Now Alliance.

Mr. Paulson, who is philosophically opposed to federal meddling in markets, at first rejected a sweeping approach to loan modifications when the idea was floated by Federal Deposit Insurance Corp. Chairwoman Sheila Bair. 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."

Mr. Paulson had it right the first time. Even if is theoretically possible for such meddling to work, history shows that government meddling always makes things worse in actual practice. Also remember that the lion's share of the blame for this mess goes to the Fed and Congress. With that in mind, the likelihood that this bailout proposal actually makes anything better is infinitesimal.

Details are Sketchy

• 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.
• Exactly which borrowers will qualify for the freeze and how long the freeze would last are yet to be determined.
• Under one scenario, the freeze could run as long as seven years. The parties are developing standard criteria that would determine eligibility. The criteria should be finalized by the end of year.
• 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.

So now the lenders all get together and decide who can afford to pay what. I have a counter proposal. Why don't grocery stores all get together and decide how much customers can afford to pay for a loaf of bread? Seriously, that is what is being discussed here.

But let's get one thing straight right up front. This has nothing whatsoever to do with "saving people's homes". This is about saving financial institutions from collapse. And the plan will fail. It rewards those who cannot afford to pay. The details are not in yet but I suspect one measure of the ability to pay will be whether or not one is current on their loans.

Anyone who wants a freeze should stop paying their mortgage now. It's clear that lending institutions do not want those homes back. This is best explained by example, and the best example is on Calculated Risk's blog in Florida REO: Priced Below 2002 New Home Price.

That in a nutshell is why we have this panic proposal from Bernanke, the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc. (C), Wells Fargo & Co. (WFC), Washington Mutual Inc. (WM) and Countrywide Financial Corp (CFC).

Lending institutions are in a panic about the possibility of taking on more REOs. (Real Estate Owned, in this case by foreclosure).

I am not opposed to the free market working out these kinds of solutions, but the free market would not have come up with this solution. That in and of itself is another reason it will fail. In fact, had we not had a Fed lowering interest rates to 1% to foster this credit bubble, the bubble would never have gotten this big in the first place.

How those collective minds think this plan will work is beyond me. Here are three simple reasons the plan will fail:

• This plan will encourage those on the edge to fall behind just to get a freeze.
  
• This plan will foster resentment from those not being bailed out.
• This plan is a transparent attempt to make people debt slaves forever.

Point number three above is really what this misguided plan is all about. It will fail because it is in the best interest of those underwater on their loans to make it fail. People are going to understand they are way upside down on their home loans, and those people along with everyone who resents others being bailed out will have every reason in the world to walk away. So walk away they will. Book it.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com
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