The Mortgage Professor
How to Fix, Not Break Up, the Subprime Business
The federal government is under enormous pressure to do something about the subprime mortgage crisis. The proposals that have emerged appear to reflect concern for abused borrowers in or approaching foreclosure, a desire to punish those responsible for their plight, and the usual urge to score political points.
This is not likely to generate thoughtful reforms that look to long-term consequences. Doing nothing is also an option, and, in my opinion, a better one than most of the other proposals. Here are some principles that reform advocates should observe:
We should keep in mind that for every subprime borrower in foreclosure, there are at least 10 others who became successful homeowners who might not have made it otherwise. We don't have a substitute for the subprime market. Meanwhile, draconian penalties that could cripple the subprime market should be avoided.
There have been a number of ill-advised proposals. These include a moratorium on foreclosures, which would benefit all borrowers in trouble whether they deserve it or not, seriously weaken the lien enforcement system, and possibly shut down the subprime market, depending on how long a moratorium lasted and how it was implemented. Another bad idea is making loan purchasers and investors legally liable for the misdeeds of loan originators. That would without question shut the subprime market.
I have a more targeted and modest proposal that focuses on the major black cloud on the horizon: the large number of subprime adjustable-rate mortgages with interest rates that will reset to much higher levels over the next two years. Many borrowers with ARMs will be unable to make the higher payments and won't have enough equity in their homes to refinance.
I would mandate a three-year extension of the initial rate period of all ARMs that meet the following conditions: