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U.S. Lends Hand on ARMs

Laurie Kulikowski

President Bush on Thursday unveiled a government-led plan to help borrowers avoid foreclosure by, among other things, temporarily freezing interest rates on certain subprime adjustable-rate mortgages for five years.

Under the plan, devised by mortgage industry leaders led by Treasury Secretary Henry Paulson, the government will assist struggling homeowners by helping them either refinance their existing loans, moving into loans backed by the Federal Housing Administration, or by freezing adjustable-rate mortgage interest rates for certain borrowers for five years, Bush said during a briefing.

"This will bring relief to homeowners more quickly," Bush said during a press conference. "The steps I've outlined today are a sensible response to a serious problem."

Speaking to criticism that the plan was "bailing out" lenders and borrowers who took risky bets and failed, Bush defended the decision for the government to step in. He said "innovative" mortgage products have helped many Americans buy their own home, but some of those products were used "irresponsibly." Lenders made loans difficult for borrowers to understand, and some people took out mortgages they knew they couldn't pay back.

The president also noted that the problem was compounded by the securitization and sale of the loans throughout the world, which has disrupted financial markets as defaults started popping up.

"We should not bail out lenders, real estate speculators, or those who made the reckless decision to buy a home they knew they could never afford," Bush said. "Yet there are some responsible homeowners who could avoid foreclosure with some assistance."

Not all subprime borrowers would be eligible for a rate freeze. Bush's initiative also makes room for government agencies to play a greater role in assisting borrowers. The FHA will have greater flexibility to offset refinancing to homeowners who have good credit histories but who cannot afford their current mortgage payments, Bush said.

On the regulatory side, the Federal Reserve is working to require stronger lending standards that will help protect borrowers, while the Department of Housing and Urban Development and other banking regulators are also taking steps to improve disclosures on mortgages, President Bush said.

As many as 1.2 million subprime borrowers currently in adjustable-rate mortgages are estimated to be assisted under the overall plan.

Borrowers have been increasingly defaulting on their mortgage payments this year, as the resets began, because the higher rates typically increase mortgage payments by several hundred dollars a month, leaving many homeowners overextended. Foreclosures have also been rising as borrowers are unable to refinance the loans to lower interest rates.

Details of Bush's plan comes the same day the Mortgage Bankers Association released a report saying the delinquency rate for residential mortgage loans stood at 5.59% of all loans outstanding at the end of September -- the highest since 1986. Those loans in the process of foreclosure were another 1.69% of all loans outstanding -- the highest levels ever, it said in its quarterly survey on mortgage delinquencies and foreclosures.

Since the third quarter of 2006, the foreclosure start rates for prime adjustable-rate mortgages increased from 0.30% to 1.02%, while the rate for subprime ARMs more than doubled to 4.72%, the association says.

Bush's plan also comes as IndyMac Bancorp(IMB Quote), the nation's second-largest mortgage independent lender, acknowledged that it would record a loss for the fourth quarter and may further cut its dividend to raise capital.

Subprime mortgage borrowers -- those who have shaky credit histories or obtained a loan with little or no documentation -- began having problems this year as home prices began falling and the availability of credit tightened.

In a speech Monday to the National Housing Forum, Paulson identified four categories of subprime borrowers: those who can afford their adjustable-rate mortgage; those who cannot afford the lower teaser rate and will likely not be able to keep their homes; those homeowners who might choose to refinance their mortgage; and those with "steady incomes, relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate."

It is this fourth category that the Treasury is targeting for mortgage interest rate freezes.

"The approach announced today is not a silver bullet," Paulson said in prepared remarks on Thursday. "We face a difficult problem for which there is no perfect solution.

"Today's announcement is a significant step," he said. "As events unfold, our approach will continue to adapt and evolve."

The Treasury is also proposing a plan to allow state and local governments to "temporarily broaden their tax-exempt bond programs to include mortgage refinancings," Paulson said on Monday.

Bush pledged the Justice Department would pursue wrongdoing in the housing and mortgage industries and urged Congress to act on measures he said could aid homeowners, including modernizing the FHA, temporarily changing the tax code to make it more appealing to refinance during a time of falling home values and passing funding for mortgage counseling.

Bush also called on the Senate to pass legislation reforming oversight of government-sponsored entities Fannie Mae(FHM Quote) and Freddie Mac(FRE Quote).

Major mortgage lenders such as Countrywide Financial(CFC Quote), Citigroup(C Quote) and Washington Mutual(WM Quote) rallied on Thursday. Countrywide shares, in particular were gaining nearly 20%.

Randy Diamond, an equity trader at Miller Tabak, says the rise in stocks is a "reflex bounce."

"There is a plan in place -- good or bad -- by the government to help correct the subprime mortgage lending mess," he said in an email. "Banks/lenders would be first to benefit from said plan, coupled with expected help by the Fed, and you have a happy stock market."

Still the rally is likely to be "short-lived," ending if the Fed cuts interest rates next week, Diamond says.

"Sure a plan is in place, but the reality is a de-levering is in progress and until home prices come down enough rate cuts will not get the already sensitive credit market to open up that easily," he said. "We still see interbank lending at a stand still and credit spreads at wide levels -- this will need to be worked out over time."

Jim Schutz, the director of research at Sterne, Agee & Leach, says investors are skeptical of the plan.

"How this is all going to work out is a moving target and no one is quite sure what the implications of the loan modifications will be," he says. "The biggest impact will probably be not on the banks per se, but the people who hold those securities."