A focus on those ‘who need it most’

The Bush administration’s plan to provide relief to homeowners facing steep interest-rate resets on their sub-prime mortgages has gotten mixed reviews. The plan calls for lenders to voluntarily freeze rates for certain homeowners with adjustable-rate loans.

We spoke with two experts about their differing views on the program.

David C. John is a senior research fellow for the Thomas A. Roe Institute for Economic Policy Studies at the Washington, D.C.-based Heritage Foundation.

Question: What has the Bush administration accomplished here?

David C. John: They have enabled industry groups to come together and work out a solution. It’s in the bondholders’ best interests because their losses are likely to be significantly lower than they would have been if the borrowers had just defaulted.

It’s in the interest of homeowners in that foreclosed houses tend to make property values drop rather dramatically. And it’s in the interest of the rest of us because it puts the sub-prime mortgage problem on a road toward a solution.

Question: What are the strengths of the agreement?

Answer: Rather than actually lowering interest rates, lenders will prevent them from resetting. Many of these homeowners have mortgages that stay at a certain interest rate for, say, two years and then change to a higher interest rate after that.

Homeowners will be divided into three groups: First, those who are capable of paying a higher rate. This doesn’t affect them at all, because the odds are they’re just going to keep paying the mortgage as they would have anyway.

Second, the people who are so far over their heads that they can’t even afford the mortgage as it’s currently structured. This isn’t going to help them either. The only way out for them is probably going to be to default on the loan.

And third, the people who can afford their mortgage now but won’t be able to when it moves to the higher interest level. What this plan does is freeze their interest rate for a period of time -- two years, five years, etc. They don’t get out of the loan, but they get a longer period of time at a lower interest rate. The assumption is that, during that time, they will refinance.

Question: Won’t that leave a lot of people in the first two groups out in the cold?

Answer: Well, the first group doesn’t necessarily need any assistance, and the second group is beyond our help. They’re basically in a house they can’t afford. I’m not suggesting that there’s any fault or blame to place; there may be circumstances beyond their control. But this is not just a problem caused by the sub-prime mortgage situation. This is a case where people, for better or worse, are over their heads.

What we need to do is focus on the people who need it the most and the people who are going to benefit from the agreement.

Question: Why not do this through a government mandate?

Answer: A nonvoluntary agreement would require legislation. That is slow. The longer it takes -- and both the regulatory process and the legislative process take a lot of time -- the more of these mortgages would reset to higher interest rates and put homeowners on the road to foreclosure.

Also, if you went in and universally changed contract terms, that quite possibly would be unconstitutional. It also makes it much harder, for people both here and overseas, to have much confidence in our legal system and our system of contracts. That sets a precedent that could have pretty heavy repercussions in the future.

Question: How do you answer critics of the program who say it doesn’t do enough?

Answer: Well, we don’t know yet how large this crisis is.

This agreement does something quickly. It doesn’t require legislation, it respects private property, there aren’t any new subsidies, and there aren’t any side effects. It’s not a perfect solution, but it’s what we can do right now, and it’s what we can do quickly.

Question: The administration has advocated this deal as a way to keep the sub-prime bust from severely hurting the economy as a whole. Will it?

Answer: We definitely don’t want this to further affect the overall economy. Whether this is enough is an open question right now.