Tuesday, December 4, 2007

At least it will help with his handicap

Henry Paulson’s Mortgage Mulligan

The Bush administration, federal regulators, and major investment banks are “aggressively pursuing,” in the words of treasury secretary Henry Paulson, a plan to save some mortgage borrowers and their lenders from the consequences of their bad decisions. The deal is called “Hope Now.” It should be subtitled: “Worry Later.”

Part of the pact likely will call for mortgage lenders and their agents—including teetering mortgage giant Countrywide Financial and tottering financial-services giant Citigroup—to change the terms of, potentially, more than $100 billion worth of mortgages that they approved for home buyers over the past few years. In those cases, borrowers, often those who couldn’t afford high monthly mortgage payments or who didn’t have much money for down payments, took on mortgages that carried initial “teaser” interest rates. That is, instead of signing mortgages that required the same monthly payment for 30 years, the borrowers agreed to pay a super-low rate for one or two years, and then to pay a much higher one for the remaining 28 or 29 years. Investment banks then packaged and sold huge bundles of these mortgages to outside bond investors, providing the original lenders with more money to make more such loans.

For these deals to work after the teaser rates expired, the housing market could never falter, because few borrowers could afford the new, higher rates that they would have to pay in a few years. Both the borrowers and the lenders understood this risk, or should have, but they ignored it. They assumed that when the teaser rate came close to expiration, the borrower could simply refinance his loan, taking out a new mortgage with a similar teaser rate—which would buy more time for the borrower and also provide new fees to mortgage lenders and brokers. This scenario collapsed when the housing market started to decline, because a borrower can’t refinance a mortgage loan if his home is worth less than the amount of money he already owes.


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