Bush takes steps to solve loan crisis

In addition to announcing the goal of greater forbearance, Bush called for Congress to pass legislation that he supports to bolster the role of government-sponsored enterprises, such as Fannie Mae, in helping homeowners get mortgages and refinancing them.

"The Congress hasn't sent me a single bill" to help homeowners, he said.

For their part, Democrats have called the president's plan too timid. Some, including Sen. Hillary Clinton of New York, would like to see a moratorium on foreclosures.

Bush's approach to the housing crisis also has critics on the right. Many free-market advocates see the rate-freeze plan as counterproductive meddling by government. Secretary Paulson, in comments to the press, emphasized that the plan is voluntary.

"This is a private sector effort," he said.

The move toward a system for modifying loans en masse when possible, rather than foreclosing, could help banks and investors who hold mortgages, because they stand to lose if home prices continue falling. Each foreclosure can cost banks $50,000, and sometimes more, when they resell the home in a distressed market.

By some forecasts more than 1 million homes could enter foreclosure next year, even with the new rescue plan.

The plan focuses on subprime borrowers – often those with weak credit history – who bought since 2005, when home prices were near their peak. As the value of their homes fall, they can't resell and pay off their loans if they have trouble making payments.

On these loans, the initial "teaser" rate was not necessarily very low. It could be 8.5 percent on a 30-year loan where resets begin after the second year.

So freezing rates doesn't leave lenders with nothing.

But it does avoid a "payment shock" for borrowers, which could amount to $350 or more per month, experts say.

A central challenge in the current housing crisis has been that after most subprime loans were made, they were generally packaged into mortgage securities for investors to buy. Now, those investors own the rights to the mortgage payments, which raises legal hurdles when determining whether loan-modification deals are in the investors' best interest.

Paulson said that investors are "on board" with the plan, however. "The risk of litigation should be manageable."

The American Securitization Forum, which represents those who securitize mortgages, was engaged in developing the plan alongside mortgage bankers.

Eric Rosengren, president of the Federal Reserve Bank of Boston, outlined a close link between housing and the wider economy in a speech this week.

"The current problems in the subprime market are heavily dependent on economic conditions," he said. "Our research suggests that the foreclosure crisis will get worse before it gets better, but our forecast is quite dependent on how far house prices fall."

Where the housing market heads will be vital not just for the fate of subprime loans, but for the US economy. Mr. O'Sullivan doesn't predict a recession, but he sees growth falling perilously close to zero before it begins to recover late next year. He forecasts weak economic growth of 1.8 percent next year.

"Home-price decline is one of the factors that could lead to recession," says Michael Cosgrove, publisher of the EconoClast newsletter in Dallas. And with prices falling, "the Fed can ease [interest rates] significantly at this point without inflation being a concern."

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