Proposed Foreclosure Plan May Cause Double Jeopardy

December 12th, 2007

There was further criticism of the plan proposed by President Bush to help stem the flow of foreclosures in the country. As is commonly known, one of the main causes of foreclosures in the country are defaults on predatory or sub-prime loans by home owners who are unable to meet their monthly mortgage payments.

President Bush plans to reduce foreclosures by freezing the interest rates on many of these sub-prime loans through 2010, thereby insulating the borrowers of these loans from any increase in interest rates. CreditSights Inc. has reported that this measure is likely to cause damage to home owners as well as bond owners.

People who have invested in securities which put most of their money into residential mortgages will revisit their valuations in these securities as this move is likely to curb their potential profits for the next few quarters. Also, according to the report, losses due to these frozen interest payments are not going to be offset by lower foreclosure figures.

The subsequent credit crunch in the mortgage market is going to hurt home owners as well. According to the Mortgage Bankers Association, the announcement of this plan was preceded by a record number of Americans falling behind on their monthly mortgage payments, making it a two decade high. Around 1.2 million home owners are expected to borrow or take loan refinancing or make changes to their existing loan structure.

According to a report called “Robbing Peter to Pay Peter — Subprime Loan Modification Revisited”, which was published recently by the New York-based popular bond research firm said “Many of the people the modification plan is supposed to benefit — whether directly of indirectly — may be the same people the plan eventually hurts”.

This analysis by Creditsights Inc. was based on a selection of loans which had an average teaser rate of around 6 percent for the 30 year mortgage sold last year in 2006, which have slowly reset to around 9 percent this year. The analysts assume that there would be a 20 percent foreclosure rate if 50 percent of these loans were frozen, and a 30 percent foreclosure rate if they were all reset to 9 percent.

People who have invested in mortgage based securities and bonds will be hit due to losses, ratings cuts, and increased political risk due to the upcoming elections. Many of these are pension funds, state authorities, insurance companies, and other municipal authorities and institutions. This will in turn have a cascading effect on the people who are directly dependant on these organizations like pensioners, life insurance policy holders, etc. All in all, not a pretty picture.