A Small Sop for Borrowers and Investors

The Bush plan falls far short of being a miracle cure for the mortgage mess. But we think the plan is marginally positive for several reasons and that investors, as well as borrowers, should see some small benefit.

Opinions have been flying ever since the announcement by President Bush and Treasury Secretary Paulson of a subprime mortgage rate freeze. It has been called the Bush bailout plan, but first and foremost, we feel it is important to say right off the bat that this announcement is in no way, shape, or form a government bailout. Let us just say that again to stress the point...THIS IS NOT A BAILOUT. No taxpayer dollars are being used to keep people in their homes. In addition, this is not a law. There is nothing in this plan that requires lenders to operate within these guidelines.

In our opinion, this plan is really just an agreement between mortgage servicers, with the prodding of the U.S. government, to cooperate with each other and encourage borrowers to avail themselves of their options rather than face foreclosure. It serves to show people--borrowers, investors, and the market in general--that lenders are "united" in their efforts and are willing to work with borrowers (those that are willing and able to pay, we should add) to keep borrowers in their homes. Further, by working to keep people in their homes, this plan attempts to stem the flood of additional homes flowing onto the market, with an eye to reducing the downward pressure on home prices.

For borrowers, the plan has some small benefits. Even prior to the announcement of this plan, mortgage lenders were already working with borrowers who were in adjustable-rate mortgages approaching their reset dates (when the interest rate on their loans rise). As a result, we believe most of these borrowers would have been able to negotiate a workout anyway. However, we believe that the publicity associated with this announcement should make borrowers more proactive in working with their lenders, realizing that options--beyond accepting a higher rate they cannot afford--are available.

For investors, we also think that the plan may have a small positive impact. Investors in mortgage-backed securities should experience fewer total defaults and we believe this plan reduces the chance of zero return on their investment. Investors won't collect higher interest rate payments as rates reset, but this was most likely something they never expected in the first place. In previous reset cycles, borrowers would refinance into lower-rate mortgages or would sell their homes--both of which result in the investors receiving their principle earlier and neither of which result in a borrower paying a higher interest rate. Under a workout scenario, investors would continue earning principal and interest payments, but over a longer period of time, with the hope that the housing market will eventually stabilize.

For people who invest in bank stocks or are involved in the mortgage industry, the news is similar. It is in the banks' interest to have borrowers pay something on their loans rather than go into default. Banks will make more money in the long run by lending to homebuyers rather than reselling their homes if they are forced into foreclosure.

We will continue to monitor the plan's effect on the market as time progresses, but again, we believe this is a step in the right direction.

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