U.S. Treasury Secretary Henry Paulson Thursday unveils his "teaser freezer" plan to put a five-year hold on some mortgage interest rates and help keep millions of homeowners out of foreclosure. He's hoping to apply the plan to certain subprime mortgages underwritten between 2005 and this year, the rates for which are to reset higher starting in January. The administration is eager to show resolve in blunting the credit crisis that threatens to tip the economy into recession. Foreclosure notices have shot up 74% so far this year, to 1.8 million. Home prices are dropping across the country, and lenders have pulled back from the freewheeling days of just one or two years ago. More than 2 million mortgages introduced at low "teaser" rates start resetting to higher rates in January, in some cases 30% higher, putting in a bind borrowers who stretched to buy a bigger home or whose home values have dropped below their mortgage balances. Decried as a bailout of irresponsible borrowers by some and a financial industry wrist slap by others, the plan is not mandatory for the financial industry, though more than three-quarters of lenders and servicers say they embrace the idea. The biggest, Countrywide Financial (nyse: CFC - news - people ), Wells Fargo (nyse: WFC- news - people ), Citigroup (nyse: C- news - people ) and JPMorgan Chase (nyse: JPM- news - people ), who collectively service $4.3 trillion in mortgage loans, all support the plan.Still, independent mortgage-servicing firms, some of which are not overseen by federal banking regulators, could opt out, leaving their borrowers still vulnerable to foreclosure.
And investors may not like it. The financial industry lobby worked aggressively to make sure the plan included indemnification for them so investors of bonds backed by these mortgages won't sue them after lenders change the terms of the loans. The more lenders who volunteer to join the program, the less vulnerable they'll all be to lawyers, saying it had become industry practice.
Another issue: The plan only applies to those who are current in their mortgage payments but who are determined to be unable to afford higher reset rates. It won't apply to those who are already faltering, and it won't apply to those who face resets but are deemed able to afford it.
That raises the inevitable moral hazard question. "I'm very skeptical of this," says Bert Ely, a banking regulation consultant in Arlington, Va., who was among the first to say in the 1980s that there would be a taxpayer bailout of the federal deposit insurance fund in the midst of the real estate lending crisis of that decade. "It's government-sponsored collusion."
Paulson, plucked last year to lead Treasury after a successful, and lucrative, career at the helm of Goldman Sachs (nyse: GS - news - people ), pressed through the fall to get a handle on the credit crisis, though some say not quickly enough. Many in the industry said as early as last year that the housing market would slow and that millions of loans made to borrowers with shaky credit would come under pressure.
But Paulson and other banking regulators sat tight until the subprime mortgage market imploded in the summer, bringing down with it a few hedge funds and, more significant, putting a virtual freeze on the fixed-income markets.
Paulson got the biggest three U.S. banks together earlier this fall to hammer out some way of alleviating the crisis, and what they came up with was also met with harsh criticism. It was a $100 billion superfund to buy up the short-term debt of off-balance-sheet entities the banks had set up to invest in some of the mortgage securities that had come under distress.
Citigroup, on the line for $80 billion of this structured investment vehicle debt, is seen as the main beneficiary of the superfund, also backed by Bank of America (nyse: BAC - news - people ) and JPMorgan Chase. Despite efforts to get other banks on board, they haven't found many takers. HSBC (nyse: HBC - news - people ) said last month it would instead just take the $45 billion in its SIVs and put them back on its balance sheet.
Housing advocates call Paulson's plan weak, saying it falls way short of the Bush administration's purported goal of keeping people in their homes. The plan applies to certain mortgages and to those who are current with their payments, not to those borrowers already in default or facing foreclosure.
Those people are still left out in the cold. "It's very disappointing," says Michael Shea, executive director of Acorn Housing, a Chicago advocate for low- and moderate-income borrowers.
"Wall Street has made billions" on mortgage financing and securitization, Shea says, and "they blew it up by being greedy, and now they're hardly paying anything at all."
On Wednesday, presidential candidate Hillary Clinton announced her own proposals, including a voluntary 90-day moratorium on home foreclosures; a five-year freeze on rate increases; and status reports on loan workouts. She also proposed a $5 billion fund to help troubled borrowers.
Lost in the noise: Many of the largest servicers are already working with borrowers to reset terms. "Citi is engaged in ongoing dialogue with Secretary Paulson, the administration and other key stakeholders to explore solutions for the current challenges in the mortgage industry," a Citi spokesman said.
In October, Countrywide announced a $16 billion plan to reset adjustable-rate mortgages for borrowers who weren't going to be able to afford the higher rates. Countrywide has its own set of problems too. It arranged a $2 billion infusion of capital from Bank of America in September.
But the financial industry is almost certain to embrace the Paulson plan over one being kicked around in the Senate. The bill, introduced by Illinois Sen. Richard Durbin, would allow bankruptcy judges to modify the terms of a mortgage in a Chapter 13 proceeding without the lender's input.
The financial industry is outraged at the idea. "If a mortgage loan can be modified during bankruptcy, it will be far more difficult to originate or sell mortgages in the secondary market," says a Dec. 4 letter from the Securities Industry and Financial Markets Association to the Senate's Judiciary Committee. "These proposals would reduce liquidity and make it harder for Americans to obtain a new mortgage or refinance their existing mortgage, the exact opposite of what the mortgage market needs now."
