And Now… the Bailout

Help!A couple of interest rate related stories have surfaced in the past few days, both indicating a boost for the real estate market — but at what cost?

A mere rumor of a federal interest rate cut has been spurring Wall Street to buy, buy, buy. Like September’s rate cut, the nationwide housing crisis will be a causal factor if there is a decision to cut rates. Outside of ARMs and home equity lines of credit, these rates do not affect (fixed) mortgage lending rates, unless they influence the overall economy. How does that happen? People buy things on their lower-interest-rate credit card.

Are you seeing the problem here? If the housing crisis is caused by (for whatever reason) people being in over their heads on their mortgages, what’s the solution? Get people in over their heads with Encourage people to increase their consumer spending. Other people, we would assume.

The other news is a more direct fix for those people who are facing a giant mortgage hike in the next year or so. The treasury department is actively calling for sub-prime lenders to help their borrowers avoid foreclosure. Banks met with the Treasury Department on Tuesday [NYT]:

In that meeting, according to industry and government officials, bank executives said they were close to defining a uniform standard for people who would qualify for a “loan modification” — a temporary freeze on their teaser rates — and a uniform standard for how long that freeze would last.

Some advocates are asking for as long as a 7-year freeze! How long would the freeze have to be to make a real impact? And what sort of ripple would that send through the economy as banks had to make up that income? I’m very happy about people staying in their homes, but what happens next?

Opinions on sub-prime borrowers who are in over their heads range widely, from empathy for the individual who was tricked into the loan to downright disgust at irresponsible money management. How do you feel about giving these folks a break?

  • Patrick

    Two things – Given the number of people reading Redfin who are thinking of buying soon you should clarify that while these rate cuts won’t effect EXISTING fixed rate mortgages, they will (probably) lower the rates on new ones.

    Second, I believe an interest rate freeze won’t have much of an effect long term, but might spread out the surge of foreclosures long enough to mitigate the collapse of prices it might cause.

    There are two kinds of defaulters – those who are illiquid and those who are insolvent. Illiquid borrowers can’t make their current payments, but might be able to pay down the debt if it’s restructured to a longer term or a slightly lower interest rate. Insolvent borrowers aren’t going to be able to repay the principal one way or the other.

    I suspect a lot of those getting crazy ARMs are in the latter category and were counting on 20% a year appreciation to get them out of their mess. So at best this will merely kick the can down the road. But kicking it down the road might prevent a critical mass of mortgage defaults causing chaos in both the housing market (foreclosures drive down prices) and the banking world (banks generally lose money on foreclosures). In the end I don’t think it will do more than postpone the inevitable for most individual borrowers, but it might prevent a snowball effect on the larger economy by spreading out the pain.

  • ellie.wilkinson

    Yes, the rate cut shouldn’t affect existing mortgages. From what I understand, it should affect new mortgages, but perhaps not in direct proportion to the cut in the fed funds rate.

    As someone looking to buy a house right not, my biggest wish (other than the lowest possible rate for my own mortgage!) is stability in the financial markets, so that the economy doesn’t go into a liquidity-fueled recession, and make it harder for me to make my mortgage payments. To that end, I like the moves that are in the works right now.

  • Ruby

    Thanks for your feedback, Patrick. Good points.