Rate freeze? Sure -- one loan at a time

It looks like the Bush administration's call for lenders to voluntarily begin wholesale modifications of ARM loans -- freezing rates on many loans with looming resets -- isn't being embraced by Wall Street investors.

Many appear to  be wedded to the current practice of reviewing loans on a case-by-case basis, a slow process that had FDIC chair Sheila Bair wringing her hands in frustration back in October. Bair said lenders hadn't even managed to modify 1 percent of troubled subprime loans doing business that way.

One problem with freezing interest rates on ARM loans on a wholesale basis, investors complain, is you inevitably end up letting some borrowers off the hook who would be able to make the higher monthly payments.

At a House subcommittee hearing Friday, Stanford Law School lecturer Tara Twomey warned of potential "tranche warfare" among investors in mortgage-backed securities (MBS). These securities often contain pools of thousands of loans, which are sliced up into tranches that carry varying degrees of risk. Worries that they'll be sued by MBS investors can make loan servicers reluctant to engage in such loss mitigation techniques, Twomey said (see Inman News story).

Remember the deal California Governator Arnold Schwarzenegger announced a couple weeks ago with four loan servicers to allow some borrowers avoid interest rate resets? Barclays Research estimates it will only help about 12 percent of people with ARM loans, the New York Times reports.

The only way we'll see wholesale loan modifications is if Congress requires lenders to employ that and other loss mitigation techniques before foreclosing on home, Twomey said.

Freezing interest rates won't help many people, she said, because some borrowers can't even afford the initial "teaser rates" that supposedly enticed many borrowers to sign up for risky subprime ARM loans. As an example, Twomey cited the case of a 77-year-old Philadelphia homeowner with a 9.625 percent teaser rate on a 2/28 ARM loan from Countrywide Home Mortgage.

But if Congress forces lenders to go beyond voluntary measures, it might cripple one of the major objectives of the Bush administration's HOPE NOW initiative: stopping the freefall in housing prices and restoring investor confidence in credit markets that fund mortgage lending. Forcing lenders to freeze interest rates might weaken investor confidence and raise fears that the government would rewrite the terms of mortgage loans that are securitized in the future. 

On a related note, the Boston Fed today published a study arguing that subprime loans don't cause foreclosures -- falling home prices do (see Inman News story). The study didn't have much to say about WHY prices might be falling (could it have something to do with easy access to subprime loans encouraging rampant speculation?), but Boston Fed chief Eric Rosengren assured bankers there's lots of money to be made refinancing subprime loans. 

Rosengren said 20 percent of subprime loans are on owner-occupied homes with LTVs under 90 percent and FICO scores exceeding 620. Full doc, too. He said many subprime borrowers may qualify for prime loans or FHA loan guarantees, which raises the question: why did these people take out subprime loans in the first place?

The average "teaser" rate on a 2/28 subprime loan made in 2006 was 8.5 percent, Rosengren noted, which suggested to him that the real problem with subprime loans is not their rates, but that many borrowers simply can't refinance out of them these days.

In New England, 74 percent of subprime 2/28 ARM loans made in 2004 were retired within two years, and 93 percent in three years, he said.

Of course, from the consumer's perspective, racking up fees refinancing one's home every two to three years may be great for lenders' bottom lines, but may rob you of equity that you would otherwise be building up with a traditional loan.

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