A Proposal for the Federal Government to Mandate Modification of Subprime ARMs
by Dan Stephens, November 25, 2008
(If you like this plan, please recommend it to your U.S. Senators and U.S. House Representative, and consider contributing to us to support our fight for meaningful mortgage reform and economic rescue for Main Street.)
Subprime ARMs that were originated in the last several years were almost universally dangerous financial products, primarily due to their short fixed rate periods, excessively high margins and high caps on initial interest rate adjustments. The credit crisis is still largely a subprime mortgage crisis, or at least rooted in that problem, which will continue to get materially worse over the next 18 months, if effective action is not taken to stop it, since more than a majority of subprime ARMs still have not had their interest rates adjust for the first time, or continue to carry very high rates, and it is the ridiculously outsized interest rate adjustments that are the essential source of the problem. Menawhile some 25% of existing subprime ARMs are in foreclosure and about 50% are delinquent. All those ARMs need immediate repair if there is any hope to stem the foreclosure crisis. Lenders and the FHFA have been too slow to fix those loans. The hodgepodge of efforts that have been put into action so far, namely the Hope Now Alliance, the Economic Stimulus Act of 2008, and announced private lender committments to restructure loans, have been much too slow and have not had much noticeable effect in stopping the drop in housing values. Investors and homeowners cannot wait any longer for a reasonable and effective plan that can work much faster. The federal government must act to mandate a faster, more universal, reasonable solution. The plan described below is a more certain, and immediate solution that addresses the root causes of the problem, the mortgages themselves, instead of just dealing with symptoms, the drop in values, bank solvency and the illiquidity of mortgage securities.
We advocate a simple, workable, cost-free, plan to immediately alleviate the subprime mortgage crisis, and that will begin to reverse many of the other credit market problems, especially if combined with a governement funded plan to reduce the number of upside-down properties by converting excess mortgage balances to bank and personal debt not secured by the homes (see our proposal for the Housing and Economic Recovery Certificates). If Congress enacted only this plan and did nothing else, you would immediately save many currently defaulted subprime ARM borrowers and prevent most future defaults on such loans, thereby restoring much market value to the related mortgage securities and their derivatives, and also reduce prospective claims on mortgage insurance and credit default swaps.
The plan has virtually no significant adverse consequences to any of the affected parties, and won't cost taxpayers one cent. No plan can reverse all of the damage the crisis has caused, since the damages from foreclosures and drops in housing values that have already happened can't be reversed quickly or easily. Having the federal government buy up any and all types of bad loans is a terrible idea, and won't help borrowers make good on them. To the extent that any emergency action can possibly stop the credit crisis from worsening, and revive the credit markets, the proposed plan is one most essential part of the solution, and the one solution that can instantly improve the outlook for current defaulted subprime ARMs, reduce future subprime ARM defaults, and, therefore, immediately restore value and liquidity to their related mortgage securities. Following are the details of the plan.
(If you like this plan, please recommend it to your U.S. Senators and U.S. House Representative, and consider contributing to us to support our fight for meaningful mortgage reform and economic rescue for Main Street.)
Subprime ARMs that were originated in the last several years were almost universally dangerous financial products, primarily due to their short fixed rate periods, excessively high margins and high caps on initial interest rate adjustments. The credit crisis is still largely a subprime mortgage crisis, or at least rooted in that problem, which will continue to get materially worse over the next 18 months, if effective action is not taken to stop it, since more than a majority of subprime ARMs still have not had their interest rates adjust for the first time, or continue to carry very high rates, and it is the ridiculously outsized interest rate adjustments that are the essential source of the problem. Menawhile some 25% of existing subprime ARMs are in foreclosure and about 50% are delinquent. All those ARMs need immediate repair if there is any hope to stem the foreclosure crisis. Lenders and the FHFA have been too slow to fix those loans. The hodgepodge of efforts that have been put into action so far, namely the Hope Now Alliance, the Economic Stimulus Act of 2008, and announced private lender committments to restructure loans, have been much too slow and have not had much noticeable effect in stopping the drop in housing values. Investors and homeowners cannot wait any longer for a reasonable and effective plan that can work much faster. The federal government must act to mandate a faster, more universal, reasonable solution. The plan described below is a more certain, and immediate solution that addresses the root causes of the problem, the mortgages themselves, instead of just dealing with symptoms, the drop in values, bank solvency and the illiquidity of mortgage securities.
We advocate a simple, workable, cost-free, plan to immediately alleviate the subprime mortgage crisis, and that will begin to reverse many of the other credit market problems, especially if combined with a governement funded plan to reduce the number of upside-down properties by converting excess mortgage balances to bank and personal debt not secured by the homes (see our proposal for the Housing and Economic Recovery Certificates). If Congress enacted only this plan and did nothing else, you would immediately save many currently defaulted subprime ARM borrowers and prevent most future defaults on such loans, thereby restoring much market value to the related mortgage securities and their derivatives, and also reduce prospective claims on mortgage insurance and credit default swaps.
The plan has virtually no significant adverse consequences to any of the affected parties, and won't cost taxpayers one cent. No plan can reverse all of the damage the crisis has caused, since the damages from foreclosures and drops in housing values that have already happened can't be reversed quickly or easily. Having the federal government buy up any and all types of bad loans is a terrible idea, and won't help borrowers make good on them. To the extent that any emergency action can possibly stop the credit crisis from worsening, and revive the credit markets, the proposed plan is one most essential part of the solution, and the one solution that can instantly improve the outlook for current defaulted subprime ARMs, reduce future subprime ARM defaults, and, therefore, immediately restore value and liquidity to their related mortgage securities. Following are the details of the plan.
An Emergency Plan to Immediately Slow the Credit Crisis By Saving Some Homeowners and Investors with No Cost to Taxpayers
In general the plan terminates all current foreclosure proceedings that stem from adjusting subprime ARMs, and mandates that all existing subprime ARMs be modified to reasonable terms similar to FHA ARMs. The plan could be implemented either by Congressional legislation or by Presidential proclamation under the National Emergencies Act. The authority of Congress to dictate new terms of private contracts (mortgages) derives from the Supreme Court ruling of 1934 in Home Building and Loan, Ltd., vs Blaisdell, whereby the state has a right to intervene in private contracts when the general welfare is at stake. That ruling was specifically applied to a mortgage contract in relation to a depression-era Minnesota law that enabled district courts to suspend a foreclosure action, so the precedent is directly relevant. In all likelihood the President has the power to intervene to alter mortgage terms under existing legislated emergency powers whether or not the Supreme Court has ruled on such action in relation to emergency powers. In any case, Congress can ratify actions of the President after they are taken under the terms of the National Emergencies Act.
By instantly and universally restructuring the remaining troubled subprime ARM mortgages with more reasonable terms, the prospect of additional loan defaults will be diminished significantly. That will increase the values of troubled mortgage investment securities and related derivatives toward more normal long term values, and reduce the pressure on mortgage insurers. That will begin to repair the dependent balance sheets of investors, lenders, banks and mortgage insurers, and therefore restore some of their ability to lend. By suspending existing foreclosure actions additional foreclosure properties will be kept off the market, so inventories of unsold homes have a chance to diminish and the values of properties will be stabilized. Presumably all of the foregoing effects will lead to more readily available mortgage credit, further helping restore normal markets. The plan includes the following key features:
1. Terminate all pending foreclosures involving subprime ARMs whose default resulted from a rate adjusting upward by 2% or more (subprime ARMs being defined as any ARM having a margin higher than 2.75%, which almost perfectly captures all subprime ARMs and no prime or Alt A ARMs). The owner's mortgage will be modified by government fiat as described below in section 2. The owner will be allowed to sell the property or refinance their mortgage using their best credit scores and credit history that existed within six months prior to the date of their first interest rate adjustment. A loan modified under section 2 below may be put into foreclosure in the event payments become delinquent by at least 120 days, just like any other mortgage loan.
2. Promulgate modified terms for all existing subprime ARMs originated for U.S. properties since 1/1/04, the key terms of such modified mortgages to include:
2.1. A margin of 2.00% (the same as most FHA ARMs).
2.2. An index consisting of the 12-month rolling average of the monthly average yield on U. S. Treasury securities having a one year maturity (the so-called "MTA" index) (note the use of a 12-month rolling average, not the monthly index itself, which is likely to become more volatile in a fragile environment of crisis recovery).
2.3. A note rate fixed for three years equal to the fully indexed rate rounded to the nearest 1/8% as of the effective date of the law or emergency proclamation, but not less than 5% nor more than 7%.
2.4. A limit on the initial rate adjustment of 1% (same as all FHA ARMs).
2.5. A limit on the periodic adjustment of 1% (same as all FHA ARMs).
2.6. A limit on the lifetime adjustment of 5% (same as all FHA ARMs).
2.7. A limit on the lifetime rate of 8.5%.
2.8. All payments due after the effective date of the act or emergency proclamation shall be calculated using the new terms of the loan, with an amortization period of the remaining term of the loan, and current principal value including any applicable principal adjustment described in section 3 below.
3. If applicable, any amount of excess interest accrued or paid on adjusted subprime ARMs shall be credited against the current principal of any such loans whose rates have adjusted since 12/31/2005, such excess equaling the interest actually charged through the date of modification less what would have been charged using the greater of either a constant rate equaling the original starting interest rate or what the rate(s) would have been after adjustments under the terms of the loan described above in section 2.
4. Borrowers who defaulted on subprime ARMs due to their interest rate adjustments, should have their credit reports repaired as if the defaults never happened. They deserve a second chance to pay their modified mortgage and preserve their credit ratings. That would also help restore some strength to the economy, since they would have credit available again.
I must note that in order for the plan to have the maximum benefit, it is essential that the plan applies to all subprime ARM borrowers, including homeowners, second home owners, and investment property owners. A plan that leaves out owners of second homes or investment properties would leave out a huge proportion of the problem loans, and, therefore would be much less effective in stemming the crisis. They should not have been allowed in the marketplace and have damaged all their users, originators and insurers. Also, as an issue of moral equity does anybody think property investors (or speculators, if you insist) are more culpable in the crisis, and therefore less worthy of rescue, than the Wall Street bankers who actually invented the subprime ARMs, made money originating them, then made more money securitizing them, more money insuring the securities, and finally, in some cases, short selling the securities they invented and sold and expected to blow up? -END-
Posted by The Mortgage News at 11/25/2008 6:43 PM 
Categories: Mortgage Legislation,Main Street bailout,Credit Crisis,mortgage modification,Subprime Loans,Housing Values,mortgage crisis
Categories: Mortgage Legislation,Main Street bailout,Credit Crisis,mortgage modification,Subprime Loans,Housing Values,mortgage crisis
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