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The subprime suckers who paid on time

Posted by: Peter Coy on December 6, 2007

I predict a rising backlash by on-time subprime borrowers against the Bush administration’s Teaser Freezer bailout plan. As far as I can tell, on-time borrowers wouldn’t be helped, even if they are severely stressed. The aid would go only to people who had missed payments. So if you scraped up every last dime to make every mortgage payment, you’re stuck in your lousy loan. Your next-door neighbor who spent the mortgage payment at Disney World gets the bailout. Infuriating, huh?

(New stuff from here down after listening to today’s press conference.)

That’s a bit of an oversimplification, of course. The Bush Administration plan is to streamline the workout process, not change the rules entirely. Presumably, then, not everyone who’s current will be ineligible for help, and not everyone who blew a payment will get aid.

Inevitably, though, any nationwide solution is going to create some winners and losers. And the losers are going to be yelping pretty loudly.

Read this complaint from a guy who got a prudent fixed-rate loan even though it was more expensive than a teaser ARM, knowing that ARMs would reset upward. Now he’s steamed that ARM borrowers are going to get away with below-market teaser rates for the next five years.

Peter Schiff, a perma-bear who rails against America’s overspending ways, thinks that some of the people who were bailed out are going to end up defaulting when the rate freeze ends in five years anyway, and knowing that they won’t take care of their properties. He calls it “the mother of all bad ideas.”

Here’s what he wrote today:

Compounding the problem is that subprime borrowers with frozen payments on loans that exceed the values of their homes will likely chose not to pay property taxes, condo or homeowners fee, or maintain the condition of their properties. Were these properties to be sold in foreclosure at least their new owners would have financial incentives to maintain the value of their investments. Upside-down subprime borrowers will have no incentive to throw money down a rate hole, making additional payments on properties in which they have no equity and which will they will likely lose to foreclosure anyway. When these homes do go into foreclosure, back taxes and other fees on dilapidated properties will inflict even greater losses on lenders.

Also, subprime borrowers with frozen resets will be unable to either borrow additional money against their homes or sell them. As rising credit cards payments, higher food and energy bills, and stagnating wage growth or even unemployment make even paying the frozen rates increasingly more difficult, this lack of flexibility will prove fatal. Also the moral hazard inherent in offering help to only those who can demonstrate an inability to afford the reset rates, or restricting the bailout to borrowers with low credit scores, guarantees that borrowers will alter their circumstances to qualify for the aid. Therefore more loans will be frozen than is currently forecast, and the circumstances of the financial borrowers will be that much more impaired as they endeavor to pile on added debt or reduce their incomes to conform to the requirements of the bailout.

Lost in current discussion is the fact that few subprime borrowers have any skin in the game in the first place. Having put nothing down or having extracted equity in previous refinances, most subprime borrowers will lose nothing if their homes go into foreclosure. In some cases the teaser rates were so low that borrowers actually paid less then what they might otherwise have paid in rent. In fact, those who have already extracted equity have received huge windfalls from their homes and will leave their lenders holding the bag.

At today’s conference, Treasury Secretary Henry Paulson acknowledged in response to a reporter’s question that the fairness issue has already come up: “We’ve heard a number of comments like that,” he said.

His response is that something had to be done about the foreclosure mess and there’s no silver bullet. First, Paulson said that preventing unnecessary foreclosures is good not only for the homeowners, but for their neighborhoods. Second, he said that a lot of the anticipated workouts would have been done anyway, except more slowly. His implication is that the inequity isn’t any greater than it was in the past.

Actually, both arguments are questionable. There are times when foreclosure really is the best option, as Peter Schiff’s comment makes clear. And despite Paulson’s argument that this is purely a private-sector deal, it seems pretty clear that loan servicers are going to feel under heavy political pressure to go easy on homeowners. Once investors realize that they can’t trust their loan servicers to get them as much money possible, they’re going to be more cautious about buying mortgage-backed securities, and the flow of money going toward financing homeownership will slow.

Here’s what Standard & Poor’s said about the plan today. (Note the last part in bold.)

Although loan modifications that extend the mortgage’s fixed-rate period may result in lower defaults, the reduction in excess spread may offset the benefits of lower defaults resulting in diminished investor protection.

Now, putting a little fear into the mortgage-backed market is not an entirely bad thing: there was probably too much investment in housing over the past five or six years.

Funny thing, though. You don’t hear President Bush bragging that this plan will keep zombie homeowners in their dwellings for another half decade while drying up the money necessary to help people buy homes in the future.

A Resolution Trust Corp.-style bailout might have been a cleaner way of dealing with this mess. Makes me wonder whether in its zeal to come up with a solution that could be labeled 100% “private sector” for political consumption, the Bush Administration made some poor choices.

Reader Comments

just me

December 6, 2007 2:12 PM

Call me sucer to!!!

This is a horrible move for all responsible citizens. We who live within our means will end up paying for irresponsible corporate moves including irresponsible homeowners. In essence we are rewarding "crooked" behaviors??


December 6, 2007 9:03 PM

The person that got a $1,000,000 loan with a $1,000 monthly payment and an APR of 7% variable. The monthly payment on reset goes to over $7,000 a month.
what is going to happen?

Abraham Farmer

December 6, 2007 10:10 PM

How can attempting to fix prices be considered private sector?

Controlling prices is what socialism and communism is all about. I don't care about the polical, but it has proven through out history that price fixing by the government doesn't work.

So when people complain about China setting prices calling them communist fools, remember we are doing the same.

Jon Cee

December 6, 2007 11:47 PM

This bailout is disgusting! It doesn't pay to be a responsible, hard working adult. Why? The government is just going to give your hard earned money away. Why stop here? I lost money on Enron stock who's going to bail me out? Again the Government is trying to control the stock market and the housing market. This isn't capitalism this is SOCIALISM. Everyone should withhold paying any taxes until this government can start acting responsibly to the hard working US citizens of this USA.


December 7, 2007 12:48 AM

When I bought my house, I had to go a little beyond my means because that was all that was available in housing prices. I also thought that that, in a few years with pay raises and promotion from work, the mortgage payment will be within my means. Until then my family and I decided that we will do without many luxury items like family vacations. I also opted to get higher fixed 30 year rate instead of lower adjustable rates because uncertainty of adjustable rates.

As it happened, two months after we moved into our new house, I was activated serve in Iraq, with substantially less Army pay. (I was still in the Army Reserve after 20 years of service to supplement my income) I returned from Iraq with a Bronze Star and a substantial financial loss. And I did not receive any raise or any credit for promotion from work for the military time. I worked the following year and half at the same pay rate as when left for Iraq.

While I was taking enemy fires and financial losses in Baghdad for 16 months, my family kept up with mortgage by putting my then 1 and 3 year olds sons in daycare so that my wife can return to work on two jobs, and not saving for retirements or children’s education.

After two years working both of us working multiple jobs, and just as I thought I was just getting a handle on our financial struggle after Iraq, now I am on medical leave since the last year to fight cancer. I received two stem cell transplants in hope of cure. The expected recovery time from an allogeneic stem cell transplant is over a year. And I will not receive any raise for the years on medical leave – meaning when I return to work a year from now, I will be working at just above the pay rate and job position of when I bought my house.

My family is still keeping up with my mortgage with my disability insurance, my wife working two jobs while being my care giver, my parents who are on Social Security moving in with me to help out, and not saving for retirements or children’s education.

There are 1.5 million troops have served in Iraq and Afghanistan, and over 10 million cancer survivors and patients in U.S. Which one gets the next bail-out from the federal government? I will get on that que. Oh no, I better get on the bail-out line for my children’s future because I borrowed everything from it, and did not make any payments.


December 7, 2007 9:28 AM

Where is the fairnes for me? I have waited seven years, made resposible decisions, saved a 30% down payment, have 0 debt, squeezed my three teens into one room to wait this insane market out and now the government wants to keep the party going. Debt is good, greed is permissable, stupidity beyond reason is forgivable.

Jerry R. McInnis

December 7, 2007 11:08 AM

How do we foreclose while keeping people in their homes negoiating a rent agreement and possibly a repurchase at a later date instead of flooding the market with a overabundance of homes is a perspective I think that would have been more beneficial to all. The economy, the Lender, the borrower, and the communities soon to be satuated with a glut of rent houses because buyers are looking for a better place to put down roots.

Jim D

December 7, 2007 12:57 PM

Count amoung the yelping the people who decided to rent, rather than get a bad loan, since this will help keep housing at it's historically unaffordable high.

There's not a lot of winners with this plan.


December 7, 2007 1:55 PM

I have never really understood the hoobla about the sky falling because of foreclousures. All indicators show that only a 3% of homeowners would default overall. 3%?. that leaves 97%. What on earth is wrong with that. Isn't this a free market? What's our beef with Cahvez again? Home prices need a correction for a viable and sustainable home market going forward. This is only help sustain artificial values. Terrible idea.

Louie M

December 7, 2007 7:10 PM

In case you haven't noticed, the myth of America is finally dying. It's sad. Indecent, lying, dishonorable is accepted as the norm, from our leaders all the way down. Try and do the right thing-pay your bills on time, save, do without until you can afford something, and you get screwed. This latest shell game will solve nothing, and only prolong the unraveling. Democracy? Not a chance. Free markets? Are you kidding me. Socialism is the new black. And I used to be a democrat. Problem is, I don't see much difference these days. It's all over for this (great) country.


December 7, 2007 10:10 PM

I dont want my taxes going to bail out irresposible people, if they borrowed too much and cant pay, or never bothered to read their contract, than it serves them right if they lose their house.
The only bail out I would even consider is for people who had bad luck, like getting sick, not for stupid people.
97 percent of us will not default because we were responsible, if the 3 percent defaults, who cares.
No taxpayer bailouts!

Ann Heitland

December 7, 2007 10:12 PM

I agree with the sentiments that those who are irresponsible SHOULD not be bailed out; however (isn't there always an however), there are SO MANY OF THEM in this instance that if we don't bail them out they will bring the rest of us down NO MATTER HOW responsible we have been. So, we gotta do it for the common good. Let's just make it tough on them over the next five years so that we're not in the same boat five years from now -- how about weekly counseling session requirements with a tedious social worker, during the prime time of those football games they'd be watching on a big screen TV.


December 7, 2007 11:27 PM

All we wanted was for homes to become more affordable. Now the government is screwing us out of that too! What the hell is wrong with this nation?!? It's as though the government wants to push us into larger and larger hamster wheels of debit to power the banking and finance establishment to become even more insanely wealthy.

It's just sad and depressingly Orwellian.


December 7, 2007 11:32 PM

I feel like Uncle Sam just drove by in a van, opened the big sliding door and mooned me. Then at the end of the street street, he made a U-turn, and on the second pass flipped me the bird, threw a bag of flaming dog excrement at my feet, and sped off.


December 8, 2007 12:17 AM

Of Course ,bleeding hearts want to punish the responsible ie. people who pay there mortgages, and reward people whom were either to stupid to get out of an adjustable ,before it exploded on them ,or more cunning to get in an make a buck an get out .Either way ,why should tax payers pay 1 cent to help a private market.
Home ownership is wonderful ,I know ,I own.
I am not willing to pay for some else's mistake ,or worse their greed.Let the market correct ,it always does.


December 8, 2007 9:03 AM

Will they bail me out? I have been trying to be fiscally responsible and try to save for my 20% down payment since 2000. But the greedy mortgage brokers, realtors, and fiscally irresponsible borrowers have been bidding up homes beyond my savings. I keep saving more but the home prices are always one step ahead of me.

Why reward the greedy irresponsible ones? They should be prosecuted. The mortgage brokers, bankers, and realtors for misrepresenting the terms of the mortgages and the borrowers for lying on the mortgage applications. These borrowers should not be rewarded with homes they really can not afford. Now these borrowers will lie and understate their income so they can qualify for a bail out.

The government should stop interfering with free markets. Home prices were push high not based on fundamental (incomes, etc.), but by this funky financing that is now coming home to roost. The home prices continue to adjust downward to match incomes levels. This is how free markets work.

It's all about affordability Mr. Paulson! No bailout!


December 10, 2007 12:46 AM

No need to predict a backlash. It is already happening. Take a look at this poll. Close to 90% of the people oppose the bailout.

Hunter C

December 10, 2007 1:34 AM

This bail out is ridiculous, the supply and demand for housing is totally out of whack and what does the government do? They try to bail out people who gambled and lost. I’m in my mid twenties and having to save 200k to buy over priced homes is ridiculous. “Let the market return to equilibrium.”


December 10, 2007 9:11 AM

How do these people know that these are the folks that are irresponsible? Where is the evidence? Isn't this information private? How do they know that these are the responsible people trying their hardest but with stagnant wages and rising costs of living, they keep getting further behind? Maybe they thought that they would receive a raise to help out and when they didn't, things got worse for them. Isn't attendance at theme parks down? Isn't luxury spending down as well? There is a lot of pressure to not save up for stuff because credit is way too easily available. I know no one that spends like these people are suggesting. I don't see how they have any evidence at all to back up their assertions.

Sally in Chicago

December 10, 2007 10:15 AM

Dan, I feel sorry for you and wish you well. You have to make some hard decisions and one of them is probably letting go of the house. That would be less stress on your and your illness cannot take more stress.

Tony is correct. The sub-prime ownership is only about 20% of all housing ownership; and foreclosures are a small percentage. What's the great outcry and fear about? Unless this is to appease our foreign banking partners who took a hit when they bought the bad debt.

texas sailor

December 11, 2007 12:23 AM

you know everyone seem to want to bailout the irresponsile. who are the irresponsible? I think the irresponsible are the lenders who loan to those with a sketchy credit past and knew this would happen and screw a whole bunch of people just to make a buck. Now we wonder why gas is $3.00 a gallon and corn based products are going to triple in price here soon to produce a product that will still not be fesible when you run those numebers. It is time that our government grew some testicular fortitude and stopped alot more than just the money grubing lending companies. This is going to be a terribly rough road for us all.

Brandon W

December 11, 2007 2:48 PM

"[Paulson's] response is that something had to be done about the foreclosure mess and there's no silver bullet."

The premises is wrong, to begin with. No, nothing HAD to be done by the government. What needs to be done is for markets to be left alone to work the way they're supposed to and correct the errors, regardless of certain painful results. The housing bubble comes from desperate plans by the Fed and government to rescue the economy in the wake of the stock market bubble, which itself was exacerbated by faulty central planning - er, banking. What the government needs to do is leave things alone. This government intervention will only lead to another crisis. Is the U.S. to spend the rest of history jumping from fiscal crisis to fiscal crisis, each worse than the last because of more government planning and bailouts? If so, it will be a very short history.


December 11, 2007 8:36 PM

SALLY in Chicago!!

HUHHH!!?? Are you kidding us? If you think this is only about "Subprime" and what's the big outcry about"? You need to get educated FAAAST.

Once again, this is so NOT about subprime, this is about the WHOLE Mortgage market enchillada, about to be going off a cliff. There was a really good article posted by Herb Greenberg on Marketwatch the other day, titled- News from a Mortgage Insider- or somthing like that...check it out, because I thought it was a really accurate picture of what is yet to come!! The media are only beginning to report how the tide is turning toward Alt A and Prime, and if I see one more headline labeling this as a "Subprime problem, I am going to scream.
The Alt-A and Prime loans soon to be defaulting will make the Subprime crisis look like a tea party....

lone ranger

December 26, 2007 12:33 PM

Well, the reason we have a mess now started due to government interference in the interest rate arena keeping them artificially low for so long to boost the economy and stock market. As a result, the housing market became very expensive due to high demand.. which forced homeowners to stretch themselves just to buy a home. The Bush administration was bragging all along about the high rate of home ownership.
Now that the other shoe has fallend and the bubble is bursting they are "solving" the problem by more artificial manipulation of rates. This government has been highly irresponsible and is driving the country off a cliff faster than you can say record budget and trade deficits.

The one thing most people dont even touch on is how government policy has also acted as a series of straws being piled on the backs of americans....

I fear this is only the beginning, as we have yet to see the full repercussions of the senseless war in Iraq, the flood of illegal immigrants taking jobs and depressing wages, outsourcing, unaffordable health care, etc......

Its almost as if the enemies of this country have been making governnment policy trying to destroy us from within. they put a trojan horse inside our walls...called our own government.


February 1, 2008 7:17 PM

LoneRanger, I'm with you on the mess that the government created, but Bush isn't alone in this. Where were the outcries from our representatives when the market was on a rocketship ride? The runup benefited Democrats and Republicans alike, and anyone with half a brain knew this was coming... The bailout won't help individuals that couldn't manage their finances keep their homes. The bailout is sneaky way to keep their buddies in the construction/mortgage/realty industries rakin' in the dough, and to stick the rest of us with the bill. Neither party wants to be pinned with the outcome if they let the market return to normalcy... If they let the market stay its course, the irresponsible lose homes they couldn't afford and won't keep even with a bailout, the market takes a dive and people wake up from this entitlement dream, and prices fall once again within the means of the average American that stayed on the sidelines and saved his money...


February 26, 2008 6:24 PM

Folks, don't flatter yourself, the government doesn't care about struggling home owners. The bail out is for the banks.


October 7, 2008 3:20 AM

I could use a Sub-Prime loan right about now. Let me pay $800 a month on a $500,000 loan. Let's see 500k @ 6% is $30,000 a year in interest. Let the gov't pay the other 20,400. I will piss away the $1700 a month like the other irresponsible people did. It is true the banks also make a killing ran their profits and stocks up on fake profits. They get the full income as if the loan was a 30 year fixed. Math is Math. People wanted something for nothing. I say forclose. The next great scam is letting accountants sell mutual funds. Take a look at the loads on some of them. Conflict of interest. Oh they also write sub-prime. Oh did I forget the Ceo making 500,000,000.

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BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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