Sub Prime Mortgage Bailout Takes Shape

Congressional aides say the Bush administration has hammered out an agreement with industry to freeze interest rates for certain subprime mortgages for five years in an effort to combat a soaring tide of foreclosures.

These aides, who spoke on condition of anonymity because the details have not yet been released, said the five-year moratorium represented a compromise between desires by banking regulators for a longer time frame of as much as seven years and industry arguments that the freeze should only last one to two years.

Another person familiar with the matter said the rate-freeze plan would apply to borrowers with loans made at the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.

The Administration is making a serious mistake in bailing out the sub prime mortgages. The banks are getting a freebie by not having to incur the painful lessons of giving money to those who are incapable of repaying loans. Mortgagees are escaping a painful lesson in responsibility for taking on loans that they had no business being in and this move artifically maintains a high price for real estate at a time when drops in prices would make markets around the country more affordable to those who are qualified to take loans.

What we've got is a bailout for those subprime mortgagees, and they're able to lock in rates for another five years at the teaser rates. This rewards those who took on the riskiest kind of mortgages, while those who were responsible and entered into conventional 30 year fixed rate mortgages see none of the benefit. In fact, we're going to be bailing out those subprime mortgages because this whole thing is going to cost the government billions.

On the flip side, it is the emotional argument that has won the day - the Administration doesn't want to see people lose their homes because of foreclosure as the interest rates get bumped up after the end of the teaser rates to the current market rate.

I would have counseled a slightly different path. Instead of providing a moratorium, any of these subprimes would have had to convert to a fixed rate 30 year security at 2 percent higher than the initial teaser rate. So, if a teaser rate was 4.875%, the homeowner would face a new interest rate of 6.875%, which isn't far off what mortgage rates for 30 year fixed was earlier this year. Subprimes have a higher interest rate to start, but the same principle applies. The pain would be spread out among the lenders and the mortgagees, but it would stem the tide of foreclosures because the banks do not want to be in the business of owning real estate, especially at a time when prices are falling.