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Some Say Bush's Plan on Mortgage Problems Isn't Enough

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The White House ambulance belatedly arrived at the scene of the subprime mortgage crash recently, with President Bush and some banking industry paramedics trying to stanch the bleeding of the battered housing market.

Yet Bush's proposed remedy is only a small bandage on a gaping wound. It may lessen or slow but will not halt the economic problems associated with the mortgage crisis. And there's even a chance that it could make matters worse.

Over the next two years, nearly 2 million adjustable-rate subprime mortgages - designed for people who lack the credit history needed for cheaper, more conventional prime loans - will reset from their low "teaser" rates into much higher rates.

Many borrowers were stretching to make ends meet with the teaser rate and will be unable to pay their bills once the rates go up. Analysts fear that the problems emanating from the resulting spike of foreclosures could push the economy into a major slowdown or even a recession.

The foreclosure threat is particularly serious in places where adjustable rate mortgages helped push prices into the stratosphere before the market peaked two years ago.

The heart of Bush's proposed cure for this is to encourage lenders to put a five-year freeze on subprime adjustable interest rates that will be resetting between Jan. 1, 2008, and July 31, 2010.

Some critics say Bush's plan will worsen the mortgage crisis by artificially propping up home prices.

"Current home prices are still too high, having been a function of the lax lending standards and rampant real estate speculation that got us into this mess in the first place," said Peter Schiff, who heads Euro Pacific Capital in Newport Beach, Calif.

If Bush simply let the foreclosures happen, home prices would fall, allowing more buyers to enter the market, said Michael Pento, senior market strategist for Delta Global Advisors.

"Would it be a pain-free process? Certainly not. We're well past that point," Pento said. "But by keeping unqualified consumers as homeowners, (the administration) fosters an artificial environment of unfairness and inflation."

Schiff and Pento have a point. But they shouldn't worry too much. The fact is that Bush's plan will freeze rates for such a relatively small number of people that it might not have the effect they're warning about. Home prices will keep falling sharply even after Bush implements his plan.

Bush's program is intended for homeowners, not speculators, who took out loans between 2005 and last July and who have not yet missed any mortgage payments, but who would be financially unable to make payments once the rates reset.

Wall Street analysts estimate that only between 7 percent and 20 percent of troubled borrowers will be able to qualify. Even with the most optimistic estimate, that means 80 percent won't qualify: about 1.6 million borrowers.

For the borrowers who do qualify, Bush's key solution to their subprime mortgage problems is to keep them in subprime mortgages! Once the freeze is over, they'll have to cope with rising adjustable rates, switch to a fixed rate if they qualify, sell their home or let it be foreclosed upon, which could lead to a second round of the mortgage battle.

"Freezing adjustable mortgages at teaser rates will only push the problem to the next president," said University of Maryland economist Peter Morici.

There's an easy solution to that problem.

Instead of freezing their adjustable rates, the mortgagers should shift qualified borrowers into prime rate mortgages, which are still hovering around a very low 6 percent.

Many borrowers should have been in prime rates in the first place. The Federal Reserve Bank of Boston recently released a study showing that half of subprime mortgage borrowers had a FICO credit score of higher than 620 when they took out their loans. A score above 620 means that you have an adequate credit record, while 680 means your credit is good and 700 means it is excellent. FICO is named for Fair Isaacs Corp., which formulated the rating.

First American LoanPerformance, a research firm, estimates that 61 percent of subprime borrowers would have qualified for fixed-rate, prime loans. Of course, they would have qualified for smaller loans, which would have made it hard to buy a house in, say, the pricier areas of Southern California. And they would have had to actually show that they had a salary somewhere and could afford a down payment.

But they would have known what they were in for, with predictable mortgage payments over the next 30 years, instead of interest rates that would continually readjust.

Some analysts say that one reason the market is now in turmoil is that many mortgage brokers - especially those in low-income communities, dealing with financially unsophisticated borrowers - either steered borrowers into risky subprime products or stood by as underqualified borrowers signed up for the debt.

Subprime loans translate into higher commission fees for the brokers, especially since brokers typically get a lot of repeat business from borrowers who renegotiate their loans as their debts mount.

"Some steering (to subprime loans) may have gone on in lower-income areas, although I personally have never been aware of anybody doing it," said Dave McDonald, president of the San Diego chapter of the California Association of Mortgage Brokers. "I don't think it was as common here as some place like, say, L.A."

The high number of foreclosures in a place like Chula Vista, Calif., - the epicenter of greater San Diego's foreclosure problem - suggests that L.A. isn't the only place where adjustable rates for inappropriate borrowers were common.

"Home buyers were stuck with loans that they didn't necessarily need," said Orson Aguilar, associate director of the Greenlining Institute in San Francisco. "Even Alan Greenspan has said that you pretty much need a Ph.D. to understand loan documents these days. And because a lot of buyers could not understand the documents, they relied on their brokers."

You can't pin all the blame on the brokers. There were certainly plenty of home buyers and speculators who knowingly chose to take on the adjustable-rate mortgages as a gamble that rates would not go up before they resold their houses.

If the borrowers had been steered into prime loans, would they have been able to pay their bills? Anecdotal evidence suggests the answer is yes.

NeighborWorks America, a nonprofit that specializes in helping low- to middle-income home buyers achieve traditional long-term fixed mortgages, said there are much fewer defaults on those loans than on adjustable rates.

Of course, if those loans would have been used in the first place, there would have been a lot fewer home buyers in the market. Which means that home prices would not have been driven so high. Which means that this crash might never have happened. Which means ... well, we can dream, can't we?

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