As reported in the Wall Street Journal today a coalition of US Banks is near an agreement to freeze the interest rates on some subprime mortgages. The idea behind the freeze is that it will help many borrowers that are expected to have trouble meeting the higher payments, and may end up in foreclosure, when the fixed rate period on their adjustable rate mortgage ends. While the details of the agreement haven’t been ironed out yet it is possible that some interest rates would remain at their low introductory level for as long as 7 years. The coalition of banks includes some of the biggest players in the mortgage market like Wells Fargo, Citibank, Washington Mutual and Countrywide.
While on the face of it the interest rate freeze sounds great we have to temper our enthusiasm for the idea by looking at all the facts. True, the freeze would prevent some foreclosures but at what cost. By freezing the interest rate on these mortgages we are simply delaying the inevitable as some of these loans will end up in foreclosure down the road regardless as there are simply “bad loans”. Additionally the capital markets are all about risk vs. reward…the investors who purchase the mortgage backed securities that made these loans possible did so expecting a certain amount of return for a certain amount of risk. By freezing the interest rates on these loans the return for the investor will be less. Why do we care about the investors return? Because you and I are the investors! If you own have a 401K, own mutual fund shares or stock in an in
vestment bank the chances are that a portion of your money is invested in mortgage backed securities backed by sub-prime loans.
In the end there is no quick fix for the years of excess and loose underwriting guidelines from which most of us benefited in the form of double digit appreciation in the value of our homes. As per Newton’s third law of motion, “for every action there is an equal and opposite reaction”.