by John M. Curtis
(310) 204-8700

Copyright December 6, 2007
All Rights Reserved.

utting the finishing touches on a bailout for homeowners with subprime mortgages, the White House turned socialist, letting big brother rescue cash-strapped borrowers. Homeowners face increases on adjustable rate mortgages, potentially causing more defaults and foreclosures. Federal Reserve Board Chairman Ben S. Burnanke worries about how more foreclosures might push the country into recession, no matter how much the Fed tinkers with monetary policy. Poised for another rate reduction at the next Open Market Committee meeting Dec. 12, there's more evidence of economic slowdown and possible recession. President George W. Bush hopes to rescue homeowners at the expense of the lending industry, punishing lenders, especially government-insured agencies like Fannie Mae and Freddie Mac, that buy mortgages and sell securities.

      Elections years are littered with pork, throwing money at voters in hopes of winning elections. Bailing out homeowners with subprime mortgages could have catastrophic affects on lenders hoping to reclaim bad investments. Artificially low “teaser rates”—those initially below market rates that set mortgage payments—allowed unqualified borrowers to buy properties. While Bush and Congress now point the finger at unscrupulous lenders, the reality is borrowers knew what they were getting into. Predicting meltdowns in the housing or stock markets is no easy matter. But borrowers or investors who buy at the peak are always at risk of getting burned. Bailing out borrowers while punishing lenders makes no economic sense. Saving some homeowners from foreclosure won't stop the hemorrhage in the housing industry, a far more real threat to the economy.

      Domestic mortgage lenders and investment banks stand to lose billions in market worth if Bush's plan to freeze rates on adjustable rate loans passes. Lenders who retained mortgages in-house or those that sold loans to agencies like Fannie Mae and Freddie Mac, expected to secure profits from adjustments on so-called adjustable rate mortgages. Lenders have no way of reclaiming margins, if Congress goes forward with a five-year rate freeze. Despite all the anticipated foreclosures, freezing rates will make mortgage-backed securities unprofitable for portfolio lenders and those that sold investments to Fannie Mae and Freddie Mac. When those agencies issue federally-insured mortgage-backed securities, investors count on certain rates to make investments pay off. Freezing interest rates for five-years hurts bond prices and decimates the profitability of Fannie Mae and Freddie Mac.

      Over the past five years, Fannie Mae increased exposure to subprime and Alt-A mortgages, those mortgages not requiring income-verification. Fannie Mae bought essentially junk bonds with a combined value of over $76 billion, nearly double Fannie's current $37.23 billion market cap. As borrowers default, the value of the bonds continue to plummet. Expected losses from Alt-A and subprime mortgages in Q-4 could cost Fannie Mae $5 billion or 12%, further eroding Fannie's $37 share price. Fannie's CEO Stephen Swad expressed confidence that discounts on bond prices wouldn't fall below the high 90s, something overly optimistic if losses continue to mount. Like most publicly traded companies, share prices slide along with corporate earnings, causing potentially serious problems as foreclosures rise. Pressuring lenders to freeze interest rates on subprime or Alt-A mortgages could boomerang.

      Fannie Mae and Freddie Mac sold securities to investors expecting those mortgages to yield the highest possible interest rates. Freezing rates at below current market rates hurts the profitability of lenders, whose adjustable rate loan portfolio was expected to rise to current rates. Locking interest rates punishes lenders and sends the wrong signal to borrowers who signed contracts expecting rates increases. If borrowers can't afford to make mortgage payments, banks are entitled to reclaim collateral by forcing foreclosure sales. Giving subprime or Alt-A borrowers a break on rates sounds like a good short-term fix but could backfire by driving Fannie Mae, Freddie Mac and other portfolio lenders into insolvency. Fixing rates for five years would cause further discounting to investors holding Fannie Mae and Freddie Mac mortgage-backed securities.

      Freezing interest rates on the nation's 2 million subprime or Alt-A mortgages offers a good election year ploy but doesn't help the cash-strapped housing industry stem a steep decline in home values. Locking interest rates harms Fannie Mae, Freddie Mac and portfolio lenders, hoping to reclaim losses on artificially low “teaser rates” for adjustable rate mortgages. “Although the administration is finally giving the foreclosure crisis the attention it deserves, it seems that President Bush is going to give struggling homeowners far less than they need,” said Democratic presidential candidate Sen. Hillary Rodham Clinton (D-N.Y.), criticizing the White House for doing too little too late. Clinton's plan would impose a 90-day moratorium on foreclosures and freeze rates for five years, further hurting the bottom line of financial institutions and eroding the bond value of mortgage-backed securities.

About the Author

John M. Curtis writes politically neutral commentary analyzing spin in national and global news. He's editor of OnlineColumnist.com and author of Dodging The Bullet and Operation Charisma.

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