George Bush Subprime Housing Plan
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The President of the United States of America, George Bush, is preparing to deliver his subprime housing plan, a strategy that will hopefully mean that people who are struggling with their mortgages still get to keep their homes.
George Bush Subprime Housing Plan Update:
George Bushâ€™s subprime rescue plan will blunt the sharp edge of Americaâ€™s housing crisis for a small group of borrowers, but it will not keep the industryâ€™s historic slump from deepening. Nor will
it prevent the economy from slowing to a crawl in 2008. What it may do, regrettably, is reassure lenders and borrowers that Washington stands ready to save them from their mistakes.
Mr Bushâ€™s Treasury department unveiled a plan on December 6th aimed at curbing defaults by many of the 1.8m subprime borrowers whose mortgages will reset to higher interest rates in the next two years. Nearly 15% of subprime loans are already in default, destroying the value of securities backed by these loans. The prospect of a new wave of defaults and foreclosures has kept financial markets on edge for months. Credit has tightened, banks have written off more than US$50bn in mortgage-backed assets and housing has dragged the economy perilously close to a recession.
The rescue plan negotiated by the Treasury secretary, Hank Paulson, with other regulators and lenders will freeze interest rates for up to five years for some subprime borrowers. Others will be fast-tracked into new, more manageable private loans, or will be allowed to borrow from the governmentâ€™s Federal Housing Administration.
Whatever else it may be, the Bush administrationâ€™s agreement is an extraordinary intrusion by the government into private mortgage contracts. It is not, however, a government bailout in the classic sense. No public money is being used to rescue borrowers or lenders, nor is the government imposing a solution on the industry. Rather, Mr Paulson has used his influence to pressure the mortgage industry into setting a national blueprint for dealing with borrowers in danger of default.
Meddling in the markets
At one level, Mr Paulsonâ€™s meddling makes a certain amount of sense. He did not, after all, have to push very hard to convince lenders and mortgage servicersâ€”those who collect monthly loan paymentsâ€”to agree to a voluntary deal. Lenders, to be sure, had been counting on higher interest payments from subprime borrowers to boost their returns. Many subprime mortgages, for example, were due to rise to 11-12% in 2008 after an introductory rate of 7-9%. But when borrowers default, lenders and the investors who buy their loans get nothing. Better, then, to keep interest rates down and continue to receive a return of some kind.
From Mr Paulsonâ€™s perspective, a deal that prevents foreclosures may also help to calm financial markets, which have soared and plunged in recent months. By keeping foreclosed homes from returning to the market, a deal might also begin to stabilise the housing market, and perhaps place a floor under home prices. Although borrowers and lenders could, in theory, have negotiated individual solutions to their loan troublesâ€”and some have done just thatâ€”the process was taking too long. Faced with a surge in subprime interest rates and a deepening housing slump, Mr Paulson thought it prudent to use his bully pulpit to force a deal.
But the agreement, in the end, will make only a modest difference. The relief will apply only to borrowers who took out loans between January 2005 and July 2007, and whose interest rates are resetting between January 2008 and July 2010. Borrowers already struggling with higher interest rates will not be helped. The agreement will also do nothing for subprime borrowers at either end of the credit spectrumâ€”those who arguably can handle the higher interest rate, and those who clearly cannot afford a home under any circumstances. Those in the middleâ€”with enough income to make monthly payments at the lower rates, but not enough to survive the rate spikeâ€”would benefit.
How many people will be helped?
Mr Paulson says his plan may help as many as 1.2m Americans keep their homes, but the actual figure is probably closer to 250,000, based on an analysis by Barclays Capital, using a similar programme in California as a guide. For those homeowners, clearly, this agreement is good news. But how the process will work is not clear. A national blueprint may make it easier to identify those who are eligible for relief, but the process of renegotiating the loan, or applying a rate freeze, must be done individually. Lenders will need to check borrowersâ€™ incomes, debt levels and the current value of homes before they can agree to a change in the terms of the loan. Mr Paulson, in fact, acknowledges his planâ€™s limitations by saying that other relief measures are under discussion.
The strains in the US housing market go well beyond subprime mortgages. The value of property owned by households soared from around US$10trn in 2000 to nearly US$20trn in 2005, amounting to one of the largest asset bubbles in history. Those excesses have been unwinding for nearly two years, and the process is far from complete. The inventory of unsold homes is at a record high; it is that surplus stock that is driving home prices down. To be sure, the Paulson plan may help by keeping thousands of foreclosed homes from returning to the market, adding to the glut. But the Economist Intelligence Unit believes home prices, which are currently sliding at the rate of around 5%, year over year, are destined for sharper declines. By the middle of 2008, we expect prices to be falling by at least 10%.
Demand for homes will also be depressed by tightening credit conditions and still-high price-to-loan ratios. Indeed, the steady decline in home prices will keep many buyers out of the market as they wait for prices to drop even more. Nor will the Paulson deal do much to restore confidence and boost consumer spending. Most subprime borrowers are, by definition, at the lower end of the income ladder and account for only a small portion of all spending.
Mr Paulsonâ€™s plan may, over time, provide some relief for financial markets if it keeps mortgage default rates a couple of percentage points below where they otherwise would have been. But it will take months, at best, to see any appreciable relief from the new agreement. In the meantime, credit conditions will continue to tighten as bank balance sheets deteriorate and lending in the interbank markets becomes increasingly difficult.
Whatever the economic arguments for the Bush administrationâ€™s plan, it amounts to poor public policy. Americaâ€™s unfettered brand of capitalism is one of its strengths; investors may be less likely to trust a government that manipulates private contracts when conditions deteriorate. At a time when the economy is already weak and the dollar is suffering from a crisis of confidence, Mr Paulsonâ€™s awkward intrusion into the mortgage market looks more like desperation than a hedge against further trouble.