Subprime Freeze: The Hope Now Deniallance

by Alex Stenback on December 3, 2007

From the Wall Street Journal:

The Bush administration and major financial institutions are close to agreeing on a plan that would temporarily freeze interest rates on certain troubled subprime home loans, according to people familiar with the negotiations.

Lots, and lots and lots and lots (and lots, and Lots!) of chatter about the above quoted, in-the-works plan to freeze rates on Subprime adjustable ARM’s being advanced by a coalition with a puke-sounding name: The "Hope Now Alliance"

The debate on the topic boils down to this:  As officials contemplate the details of the plan, they have a very fine line to trod.  Either they concoct a plan that captures too few borrowers, which won’t solve the problem but will make the front pages.  Or, they cook up something more aggressive which captures a greater precentage of sub-prime borrowers, but will have all sorts of unintended consequences like bondholder lawsuits, rewarding those who overextended, inspiring defaults-on-purpose to get relief, or simply delaying the inevitable.

Here’s our prediction:  What we will get is an agreement that captures only a very small slice of sub-prime borrowers – certainly not enough to make any sort of significant den’t in the problem – but enough to score PR points, and garner some big headlines.  This may be by design, or by accident.

Here’s why:  Even with prime home loans, the circumstances leading to a borrower default are incredibly diverse, complicated and varied.  Rarely do they boil down to a single factor such as an ARM that is adjusting.  Now we have a generation of sub-prime mortgages whose original structure, underwriting, appraisals, etc. are all suspect, if not outright fraudulent, which means that even the most aggressive plan may not offer much help.

In other words, we just may find out that mamy sub-prime loans are so bad that the borrowers are beyond the help any freeze or modification will offer.  It just won’t make any difference. You can’t exactly fix a loan that should never have been made at all, at any terms, in the first place.

Either way, any meaningful solution will require sorting through the universe of sub-prime loans and looking at each borrowers situation on a case by case basis. Nothing more, nothing less, and anyone who argues otherwise is in denial about the true nature of the problem.  This is heavy, resource intensive, expensive work, and the industry does not have the infrastructure (or resolve, apparently) to do it.   

Complicated problems don’t ever get fixed by uncomplicated "lets freeze all ARM’s" solutions.  Until the industry and politicians grasp that central fact, it will be much easier and cheaper to slap a one size fits all non-solution solution on problem and grab a few cheap headlines in the name of doing "something," which is what we fully expect out of this Hope Now Alliance, which we are officially dubbing the Hope Now Deniallance.

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