It is unfortunate that most reporting on the rash of foreclosures in the mortgage market continues to focus on the mortgages as the source of the problem. This is leading to seriously misguided policy, since the core problem is falling house prices, not resetting mortgages. This basic point should be obvious. Suppose house prices had continued to rise by 10 percent a year, as they had been in many hot markets. No one would be defaulting on resetting mortgages, since they could either borrow from the new equity to meet their payments or they could sell their home and put money in their pocket. The reason that subprime borrowers are defaulting in large numbers is that prices are now falling so that they have no equity to borrow against. The reset can be the event that triggers default as efforts to keep up mortgage payments becomes hopeless, but many subprime borrowers are defaulting even before the reset. The basic problem is that they are in over their head, seduced by the proselytizers of homeownership. These people will obviously not be aided by a freeze on resets. Neither will the people whose mortgage has already reset. And of course the people who tool out fixed rate mortgages will not benefit either. And, moderate income homebuyers who had good enough credit to qualify for prime mortgages also will not benefit from subprime freeze plans. It is hard to justify not helping these other groups of mortgage holders, but this is exactly what will happen if we proclaim a subprime mortgage reset freeze and then pronounce the problem fixed. The fact of the matter is that the rate of foreclosure will not be hugely affected by the freeze, many subprime borrowers will default even at the teaser rate. In addition, we will continue to see further growth in foreclosures in these other categories of loans. In addition, this policy creates the perverse situation in which the homebuyer who had the sense to request a fixed rate mortgage is paying a higher interest rate than the person who gambled on an ARM. Many homebuyers with fixed rate mortgages were also not given full information about the costs and risks of homeownership when they took out their loans. This is what happens when policy is designed by people who simply have no understanding of the problem. And yes, my "own to rent" plan is far better targetted.
--Dean Baker [The Government Accountability Office has a nice graph (p18) which clearly demonstrates that the problem is not the resets. It shows that more than 10 percent of the subprime ARMs issued in 2006 were seriously delinquent or in the foreclosure process within a year after issuance. This is important because no mortgages reset during this period and the vast majority would not reset until at least the 24 month point. So, resetting rates are clearly bad news for people who are already struggling, but a freeze is not the end of their problems.
