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How to Fix, Not Break Up, the Subprime Business
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The second and third conditions are crude ways to limit the benefit to the most deserving. The fourth condition is designed to narrow eligibility to the borrowers most likely to need the extension, who are also the borrowers most likely to have been overcharged. (The margin is the number that is added to the interest rate index to determine the new rate at reset. The higher the margin, the higher the new rate.)
The last condition also means that the extensions of the initial rate periods, and the costs associated with the extensions, would be concentrated in the subprime market. Almost all subprime mortgages have margins exceeding 4 percentage points.
Most of the mortgages affected by extension of the initial rate period will be in trouble without the extension. Hence, any additional loss to investors and any effect on new lending should be very small.
Next Saturday, I'll look at whether the subprime market can be replaced.
Jack Guttentag is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He can be contacted through his Web site, http://www.mtgprofessor.com.
Copyright 2007, Jack Guttentag
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