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Washington Abandons Subprime Borrowers

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By propping up home prices and lowering interest rates, policymakers push distressed homeowners deeper into trouble.

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The White House, Congress and Federal Reserve are coordinating efforts to spur the economy and jumpstart the stalled housing market, but the initiatives fall short of providing aide to borrowers who need it most.

Washington is using a three-pronged approach to address the U.S. housing downturn: lower interest rates, tax rebates, and expansion of the role of Fannie Mae (FNM) and Freddie Mac (FRE) – the two government sponsored enterprises, or GSEs, that own or guarantee half the nearly $10 trillion outstanding American mortgage debt.

A lower Fed funds rate will drag down Libor – an index often used as a base for the adjustable rate mortgages written during the housing boom. When ARMs ratchet upwards, the low introductory rate jumps to one determined by a spread that can be as much as 5% greater than the Libor rate. Although a lower Libor rate will mean these shocks are less painful for struggling borrowers, it may be a moot point: more than 20% of outstanding subprime loans are already delinquent, despite the fact that loans originated in 2006 – the worst vintage of mortgages in history – have only just begun the reset process.

Loan delinquencies are getting worse at a faster rate, meaning the New Hope Alliance's attempt to freeze interest rates for subprime borrowers comes too late to help many fighting to make ends meet.

Tax rebates of between $600–1200 may in the best case push out delinquency for a month or two for those in the most dire conditions, and in the worst will simply be used to pay down other debt. This shortsighted public relations stunt irrationally assumes that a handout will cure years of irresponsible consumer behavior.

Finally, upping loan limits for Fannie and Freddie will help only borrowers in the best financial conditions. In addition to limits on loan size, the GSEs have strict requirements for income verification and down payments that most subprime borrowers cannot meet. Wealthy home buyers in states like California, Florida, and New York will find it easier to get a loan, but without a functioning secondary market for subprime mortgages, borrowers with poor credit, no money for a down payment and little to no equity are still stuck.

The only positive to be gleaned from the proposed stimulus package is an expansion of the role of the Federal Housing Administration, or FHA, which provides loans to certain subprime borrowers. Although the FHA means well and many of its programs do help low-income home owners, the implicit backing of the FHA gives loan originators no incentive to prudently underwrite a loan, inviting rampant fraud and predatory lending into the market for FHA loans.

Washington is caving to pressure from Wall Street and real estate groups that stand to lose if home prices continue their downward slide. The CFO at Los Angeles-based KB Homes (KBH) sums up the conflict of interest by saying the stimulus package "[is] a shot in the arm to the market. It's going to spur people to move up to a more expensive home, and that's going to get the new and used markets moving again."

By propping up home prices and lowering interest rates, policymakers push distressed homeowners deeper into trouble, while bailing out banks and homebuilders who profited from putting thousands of families on the streets.


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