The Bush administration's plan to help troubled homeowners avoid foreclosures through a broad loan modification strategy has been met with mixed reactions, and could raise the threat of investor lawsuits.
The plan, announced on Thursday, would freeze for up to five years the interest rates of some subprime borrowers. President George Bush has said that up to 1.2 million people will be eligible for assistance. However, according to reports, only a fraction will actually qualify for the rate freeze. Other borrowers will be able to refinance existing loans into new private mortgages or have them moved into an FHASecure loan.
The new program was hashed out through meetings between Treasury Secretary Henry Paulson and representatives from various sectors of the mortgage industry. A private-sector group called the HOPE NOW Alliance was formed to help come up with the strategy. The American Securitization Forum (ASF) developed the framework for the modification plan.
While the Bush administration received praise from some groups for stepping in to help the struggling subprime borrowers, the response was tempered by the general feeling that the plan's impact will likely be narrow. The Center for Responsible Lending called the plan "a positive, but very limited, first step," and estimated that it would only help 7% - or about 145,000 families - of subprime borrowers.
The CRL cited the Moody's Investors Service study that found servicers had only modified about 1% of resetting subprime loans through July. "The plan relies on voluntary decisions by individual mortgage servicers and investors, does not remove the strong financial and legal incentives servicers have to foreclose on loans rather than modify them, and ignores the obstacles to modification posed by piggyback' second mortgages," the organization said in a statement.
But Paulson cited the plan's ability to "streamline" the modification process and said the administration "saw a role for government to develop a framework" to prevent borrowers from losing their homes. "The standard loan-by-loan process would not be able to handle the volume of work that would be needed," he said at a press conference Webcast on Thursday.
Still, Paulson acknowledged that the plan would only go so far in helping at-risk subprime borrowers. "The approach today is not a silver bullet," he said. "We face a difficult problem for which there is no perfect solution."
The plan also raises the specter of potential lawsuits from investors, a threat that has reportedly slowed the process of loan modifications in the past. Investors are concerned about reduced payments from borrowers, and also the possibility that a costly foreclosure is just being delayed.
Joshua Rosen, managing director of independent research firm Graham Fisher & Co., said that most investors will react after a plan is presented, rather than giving their input while the plan is being developed. "Investors rarely work as a group and don't really want to show you what's in their book," he said. "They don't want to show their exposure. But we all know there is a huge threat of lawsuits and I believe you are going to see a lot of litigation."
Rosen argued that the plan is akin to "reaching in the darkness for the light switch" to solve the credit problem. "The difficulties we are facing came about because we built new securities and made assumptions about collateral without a lot of empirical data," he said. "And now we're going to skew it by changing the market. It doesn't allow us to learn from our mistakes and doesn't allow the market to unwind in order to see how to fix it."
Asked at the press conference about the possibility of litigation from investors because of the framework set forth by the modification plan, George Miller, executive director of the ASF said, "It is no complete insulation from legal exposure."
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