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In the News : Subprime Lending
Publication: The Financial Times
By: Matthew Garrahan in Los Angeles and Krishna Guha inWashington
Date: November 26, 2007
California seals loans deal to head off defaults
Arnold Schwarzenegger is once again leading US states to action on policy reform ahead of lawmakers on Capitol Hill.
The California governor, who this year introduced environmental and healthcare reforms, has now moved to slow the rate of home loan defaults brought on by the collapse in the subprime mortgage market.
Mr Schwarzenegger's deal with four of the state's biggest mortgage lenders - Countrywide Financial, GMAC, Litton and HomeEq - is "nothing less than jaw-dropping in its ambition and implications", according to Matt Fellowes, a fellow with the Brookings Institution.
Under the scheme, the lenders will extend, for a "sustainable" period, low introductory rates on adjustable loans to homeowners at risk of foreclosure. That would address a serious headache for policymakers - the large number of adjustable-rate home loans taken out at low introductory rates and due to reset at higher rates in the next few years.
Adjustable rate mortgages (ARMs) make up about 30 per cent of all US home loans and are more prevalent in the subprime market. More than $350bn (£170bn, 236bn) in ARMS will reset to higher rates in the next 18 months.
Analysts and ratings agencies alike say these resets will increase the frequency of loan defaults as falling house prices leave borrowers with negative equity and no chance of refinancing.
That could further hit -consumer spending, with knock-on effects on US and world economies already suffering from the effects of the credit squeeze.
Attempts to avert such a scenario by encouraging mortgage lenders and servicers to renegotiate home loans have not gone as far as policymakers would hope.
While investors generally agree that, in many cases, it is better if a loan is restructured rather than going into default, there is great resistance to standardised solutions based on simple criteria such as type of loan and status of -borrower.
Many investors feel such standardised solutions will benefit borrowers who can afford to make higher payments and want to proceed instead on a case-by-case basis, albeit with standardised systems and databanks.
Hank Paulson, US Treasury secretary, last week expressed
his frustration at the slow pace of mortgage restructuring
in the private sector and urged mortgage servicers to adopt
a more standardised approach.
Randall Kroszner, the senior Federal Reserve official on housing
matters, has also advocated a more standardised approach.
Federal officials are seeking further information on the California deal and could not indicate whether there might be the potential to extend this solution either state-by-state or nationally.
However, there is interest in the approach. "It has the potential to save tens of thousands of Californians their homes and perhaps hundreds of thousands of homes across the country by proving . . . that the public and private sectors can -collectively work together," Mr Fellows said.
Michael Krimminger, special adviser for policy with the Federal Deposit Insurance Corporation, which guarantees deposits held by banks, says the plan will be a catalyst for other states.
"The influence that the governor of California can bring
to bear means there will be a big push for this [across the
US]," he said. As the companies involved service loans
across the US, the plan is "very scalable across the
country".
California has not promised financial or legislative incentives
to the lenders, says a spokeswoman for Mr Schwarzenegger.
"This is a public private partnership that does not involve
public dollars." Instead, it is backed by "safety
in numbers".
"If only one company were modifying its loans . . . they would lose out to the competition," she said. However, with four lenders representing 25 per cent of subprime mortgages signing up to the plan, the risk to the lenders has been minimised.
The agreement with the lenders will cover only those homeowners
"making timely payments". Beneficiaries will also
need to prove they cannot afford a rate rise.
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