Help is coming to address one of the most important factors hammering the US housing market: the large number of homeowners at risk of foreclosure because their interest rates will soon reset upward.
The emerging plan – a voluntary effort to temporarily freeze mortgage interest rates for some – won't be a one-step fix for the nation's mortgage troubles, said Treasury Secretary Henry Paulson, who is coordinating the private-sector plan. But it would provide meaningful aid to as many as 1 million homeowners facing foreclosure.
It could also help the economy escape a possible recession next year. A rising tide of foreclosures has become a key force behind the unusual severity of the current housing downturn.
"There's no silver bullet," says Brian Bethune, an economist at Global Insight, a forecasting firm in Lexington, Mass. But reset relief "is going to help." In much of the nation, home prices have been declining over the past year after a historic run-up. The good news is that the decline is helping to make housing more affordable for buyers who had been priced out of the market. Over time, that should help restore a balance of supply and demand.
But right now, the economy faces some risks if home prices fall too far. The further prices fall, the greater the number of recent home buyers who will go "upside down," having homes that are worth less than the balance of their mortgage loans.
The result could be even more foreclosures – and more homes up for auction in an already glutted market.
Banks, already smarting from large losses tied to mortgage loans, could further restrict credit to new home buyers out of uncertainty about property values.
"The mortgage markets can't withstand that kind of pressure," Mr. Bethune says.
Lenders have already been tightening credit standards in response to a shifting economic climate. They felt they could lend on easy terms when prices were rising, but with prices falling they have less appetite for risky loans.
Against this backdrop – rising borrower defaults and tighter bank credit – the Bush administration is under growing pressure to contain the economic fallout.
At a housing-related conference Monday, Secretary Paulson discussed the emerging plan to help at-risk borrowers.
The basic idea is for banks to allow many homeowners who have adjustable-rate loans to postpone a rate reset that they won't be able to afford. Instead, they would keep paying their initial interest rate, which are often low "teaser" rates.
The plan wouldn't give help to people who are already behind on their loans. Nor would it cover people who can afford to pay the mandated reset. Still, as many as 1.1 million homeowners could fall into the middle category – able to pay their current rate but not the higher reset one – and could qualify for help.
What's in it for the lenders? They would lose some potential income, but they would gain by having fewer costly foreclosures to process. And it could help stop the downward momentum in home prices that threatens the industry.
"I am confident they will finalize these standards soon," Paulson said, referring to the loan-servicing companies and lenders in an alliance called HOPE NOW. "As a result, what was a fragmented, cumbersome process can be a coordinated effort, which more quickly helps able homeowners."
Indeed, a central virtue of this plan will be speed.
Currently, mortgages are resetting at such a pace that companies holding the mortgage loans can't process such "workout" deals with borrowers as fast as loans are going into default.
The Treasury's goal is to help banks develop large "categories of borrowers eligible for appropriate modifications and refinancings," Paulson said.
Some economists and federal officials have been hoping that the mortgage industry can shift many borrowers from adjustable-rate mortgages (ARMs) to fixed-rate loans. But according to news reports, industry participants w opt to simply postpone the day of reckoning. Instead of resetting next year, eligible borrowers might get to continue paying their teaser interest rates for two to five years.
But anything that helps borrowers caught in the middle – those who have jobs and incomes but can't afford the reset – could help the economy, analysts say.
"I am leaning towards liking the administration's Teaser Freezer plan," economist Ed Yardeni, head of his own Great Neck, N.Y., research firm, wrote in a note to clients Monday. "Are we making some progress toward resolving the credit crisis? I think so."
Despite the economy's strong performance in the third quarter of 2007, many economists see the US as walking a fine line between recession and growth in the months ahead.
The housing slump has hurt not only the construction industry but also the ability of consumers to tap housing wealth through refinancing their mortgages and taking some cash out.
Bethune says the loan modifications are just part of a multistep housing recovery plan that is needed.