A suitable plan
Countrywide Financial Corp., the largest U.S. mortgage lender, announced a new effort this week to contain the meltdown in the sub-prime market. The Calabasas-based company said it would refinance or modify up to 70,000 adjustable-rate loans -- less than 1% of the mortgages it services -- to aid borrowers whose interest rates will ratchet up by the end of 2008. It also plans to offer new deals to troubled sub-prime borrowers whose rates already jumped, potentially helping 10,000 more. The total value of those mortgages is about $16 billion.
There’s less to admire about Countrywide’s move than these numbers suggest. Most of the homeowners affected pose little or no risk to lenders. Either they’ve proved that they fit the profile of a prime borrower, or they meet the requirements set by Fannie Mae and other agencies that guarantee loans. Either way, they qualify for mortgages with significantly lower interest rates than their current loans will soon impose. Countrywide wins no angels’ wings for steering these borrowers into more affordable prime loans.
Other elements of Countrywide’s plan, however, set an example for lenders and investors, because they sacrifice potential (but likely unattainable) profits for the sake of avoiding foreclosures. One program would offer better loan terms to prime and sub-prime borrowers with dim prospects for refinancing and who can’t afford the higher rates their loans are due to charge. The other would cut rates for borrowers already in trouble. These modifications will cost Countrywide and the investors that currently own the loans, which Countrywide packaged and sold to Wall Street. But a reduced return is better than what investors and Countrywide would be left with should the borrowers default. With property values dropping, some of those properties are likely to be worth less than the balance of the loans.
This approach is the most direct response to the burgeoning problems in housing finance. The damage inflicted is so extensive, to individuals and to their communities, that some policymakers have pushed for federal, state and local governments to intervene. But it would pose a significant moral hazard for the government to use tax dollars to save borrowers from defaulting. That kind of bailout would rescue lenders and investors from the consequences of their reckless bets on an ever-appreciating housing market, as well as rewarding borrowers who knowingly took on too much debt. It’s far better for lenders and investors to absorb losses on loans that never should have been made, while accepting smaller returns from borrowers who can afford no more than a small premium over prime rates. After all, most have been paying a premium for their homes since Day 1.
