U.S., Banks Near A Plan to Freeze Subprime Rates

Now we hear that the Treasury Department is intervening on behalf of those who default on their mortgage loans

WASHINGTON -- 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.

An accord could reassure investors and strapped homeowners, both of whom are anxious as interest rates on more than two million adjustable mortgages are scheduled to jump over the next two years. It could also give a boost to the Bush administration, which is facing criticism for inaction amid the recent housing turmoil.

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.

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.

Is this a good idea? It is certainly good for the borrowers who are in default. But if you were to ask me if it is good for the country as a whole, there are several reasons why it may not be:

(1) The subprime borrowers are in effect being bailed out by the influence of the government. They put themselves into this mess by agreeing to a loan contract that they could not afford. Will the bailout give them the confidence to enter into future contracts that they cannot afford, thinking that the government will bail them out again? There is a significant probability of a moral hazard problem.

(2) Some say that they were induced to sign loan contracts that they did not understand! How ridiculous is this? No one should EVER enter into any type of financial contract they do not understand.

(3) The lenders and investors who made the mortgage loans did so under the expectation that the interest rates would automatically increase. Now there will be a freeze on the rates. Thus, the investors cannot rely on the basic premise that their contracts will be enforced as written. Many investors will desert the mortgage loan market, making it more difficult for future homebuyers to get a mortgage loan.