It looks as though President Bush and several of the leading presidential candidates are finally getting serious about helping people who are being hit by the collapse of the housing bubble. The proposal to freeze the interest rate on adjustable rate mortgages at their teaser rates is far more serious than anything previously placed on the table. It has two very positive features that distinguish it from grand plans to have Fannie Mae and Freddie Mac buy up all the bad mortgages in sight. First, the benefits are targeted on the homeowners, not the investors. There is no reason to come to the aid of investors holding bad mortgages; they were supposed to have known what they were doing. The second positive feature is that the restriction on resets does not require any government money or new bureaucracy, both of which are definitely big selling points. However, the interest rate freeze also has some important drawbacks that the media has thus far failed to investigate. The obvious question that should be asked is whether the plan is helping the people who we want to help. The answer here is mixed. It is helping the people who took out adjustable rate mortgages that have not yet reset; a group that includes speculators and wealthy homeowners. (Of course, many homebuyers are defaulting even before the reset, suggesting that they are having problems even paying the teaser rates.) The freeze does not help people who took out fixed rate mortgages or homeowners whose mortgages have already reset. As far the undeserving gainers, many high income people calculated that they were better off starting with a low adjustable rate for a few years and then taking a chance with the higher rate to which their mortgage would reset in two or three years. These people were and are fully prepared to pay the higher reset rate. It is not clear that there is any public interest served by preventing this reset from occurring. In the same vein, many speculators who bought houses as investment properties also have ARMs that will reset. These people should have known what they were doing. If the resets cause them to lose their home is there any reason that we should care? On the other side there are many low and moderate-income homebuyers who either took out fixed rate mortgages or already saw their ARM reset to a higher rate. This freeze does nothing for them. Some people may question the need to help a homebuyer who took out a fixed rate mortgage, since they were not deceived into taking out a mortgage the cost of which jumps in later years, but many of these homebuyers got their mortgages through the same mortgage agents who pushed predatory ARMs. While they may have used good judgment in not going for an ARM (and had the resources to pay a higher fixed rate), is there any reason to believe that the mortgage agents were any straighter with these people about the full costs of homeownership (e.g. taxes, insurance, maintenance costs) than they were with the people who took out ARMs. The foreclosure rate has been much lower among those taking out fixed rate mortgages, but this is likely due to largely to a self-selection process. The homebuyers who could afford to get fixed rate mortgages were somewhat better situated and will be slower to default. But the default rate is still high and rising among this group and many will be losing their homes without assistance. It is also important to think about the message the freeze sends to market. It makes the issuance of ARMs considerably more risky for lenders since there is the possibility of a government imposed freeze. This will cause the future rates on ARMs to rise relative to fixed rate mortgages. That is not necessarily a bad thing, but ARMs are not always bad, and we should at least note this as one of the consequences of an across the board freeze. Anyhow these are issues that the media should be exploring and has not thus far. Of course, my “own to rent” plan does better in terms of providing targeted assistance to those most in need, but even if they don’t end up endorsing my plan, reporters should be asking the right questions. (The own to rent plan would only benefit those who bought a house at below the median price in an area and it is does not distinguish between the type of mortgage the homebuyer had taken out.)
--Dean Baker
