Does the Housing Plan Go Far Enough?

Even as Paulson unveils his long-awaited plan to help homeowners, there are many questions

by Jane Sasseen

Treasury Secretary Hank Paulson. Tim Boyle/Getty Images

With the growing mortgage crisis threatening to send the economy into a tailspin, help is on the way. On Dec. 6, Treasury Secretary Henry Paulson announced a much anticipated plan aimed at preventing a wave of foreclosures among homeowners facing sharply higher monthly payments on adjustable-rate mortgages that will soon reset.

The plan, unveiled with Housing & Urban Development Secretary Alphonso Jackson and with the blessing of President George W. Bush, comes after weeks of tough bargaining with lenders, investors in mortgage-backed securities, and loan servicers—the folks who collect mortgage payments for investors.

The centerpiece of the initiative is an agreement by lenders to freeze interest rates for up to five years for at least some portion of the 1.8 million subprime borrowers in danger of losing their homes as their mortgage payments spike up by the end of 2009. Borrowers who qualify for assistance will have their interest rate frozen at the initial starter rates, which generally run between 7% and 9%. "We have worked through an evolving process to help minimize the impact of the housing downturn on homeowners, neighborhoods, and the U.S. economy," said Paulson. "The infrastructure to reach struggling borrowers is now in place."

Standard Criteria to Speed Process

Reaction to the plan was mixed. While Democrats on Capitol Hill and on the campaign trail argued it didn't go far enough, some conservatives decried what they see as overstepping by the government in pushing the private sector into agreement. Still, many in the mortgage industry were relieved to see movement. Although plenty of questions remain, Rod Dubitsky, managing director of fixed income research for structured products at Credit Suisse Securities (CS), says, "This is a good start."

Critical to the plan's success is how quickly it will speed the workout process for homeowners—and for how many. Until now, loan modifications have been painfully slow. Because many lenders have been overwhelmed by the number of borrowers already running into trouble—and they've been dealing with those borrowers on a case-by-case basis—only a minuscule number of homeowners facing default have been able to renegotiate their loans. The idea of the workout plan is to speed up the process by laying out standard criteria under which homeowners will be eligible for aid. "We hope that these guidelines will be adopted as reasonable and customary standard practice across the entire servicing industry," said Paulson.

Not every troubled homeowner (BusinessWeek.com, 12/6/07) need apply. For starters, the rescue plan will only apply to homeowners who took out adjustable-rate subprime loans between January, 2005, and July, 2007, and which are resetting between January, 2008, and July, 2010.

A Small Group Will Benefit

Within that group, those who will be able to continue to pay their mortgages even after resets won't qualify for relief. Neither will those already struggling to pay their mortgages even before resets; they, too, are out of luck.

Instead, the plan will concentrate on two groups. Those with enough equity in their homes, or enough income, to be able to refinance will be fast-tracked in new loans.

But the core of the relief effort will be targeted at those who are currently paying their mortgages but will be unlikely to be able to continue doing so after the reset. To screen for those who potentially qualify, servicers will focus on those who are no more than 30 days delinquent on their current loans, and had equity of just 3% or less in their homes at the time the loan was made. Lenders will then look at financial criteria—primarily a homeowner's FICO score—to determine whether they are eligible for the rate freeze. "This will allow us to move through the cases much faster," says Michael Heid, co-president of Wells Fargo Home Mortgage (WFC).

The plan's details raised as many questions as they answered. Chief among them: Given those restrictions, just how many homeowners will be helped? "The plan seems like it will help reduce foreclosures, but the question is how much," says Alec Phillips, a Washington policy analyst for Goldman Sachs (GS). According to Heid, holders of roughly 1.2 million of the hybrid ARMs scheduled to reset could get some form of assistance. He says roughly 600,000 will likely have their loans refinanced, while a "significant portion" of the remaining 600,000 will benefit from an interest rate freeze. Informal industry estimates place the number somewhere between 240,000 and 500,000.

How Well Will It Work?

Heid, who played a key role in helping negotiate the deal, believes it will go a long way toward helping struggling homeowners. But many bankers and those in mortgage services continue to question how well a systematic approach will work. Even with broad criteria in place that help identify those potentially eligible for a workout, many say actually going through the details of renegotiating a mortgage will remain an intensive, loan-by-loan process. They argue they will still have to look at such things as whether the value of the house has fallen, along with the disposable income and debt level of the borrower, to complete a workout.

"There's only so much that can be done from Washington," says James Montgomery, who was chairman of Great Western Financial when it was sold to Washington Mutual (WM) in 1997, and who has since founded two community banks in California and Utah. "You've got to look at deals individually, and at local market conditions."

Some housing advocates also decried what they see as the plan's narrow focus, arguing that far too many people will be excluded from help.