Part Two: Who the Treasury Secretary's Mortgage Bailout Plan Doesn't Help

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This is a three part article. 

Part One:  Treasury Secretary Offers Sub-Prime Bailout Plan

If you’re one of those millions who face foreclosure after your interest rate resets, will Treasury Secretary Henry Paulson’s plan help you?

Paulson has pitched a proposal, reached in negotiations with the mortgage industry, which would freeze introductory "teaser" rates on subprime mortgages, preventing them from resetting to higher rates for five years.

President George Bush has stressed that the deal is not a bailout because no government money is involved.

The effort is aimed at stemming a threatened wave of foreclosures in coming years as 2 million subprime mortgages reset from their introductory teaser rates of around 7 percent to 8 percent to levels as high as 11 percent, adding hundreds of dollars to the typical monthly payment.

So far, little progress has been made in heading off the looming foreclosures. Of some $950 billion in loans scheduled to reset this year or next, only 1 percent have been modified after resetting earlier this year, according a September survey by Moody's Investors Service.

Mortgage companies will offer to freeze the loans at the lower introductory rates as long as the borrowers did not miss any payments at the lower rate.

The financial services industry applauded the administration for negotiating a plan that will allow free-market forces to operate. The hope is that the five-year freeze will buy time for the housing industry to work down record levels of unsold homes and for sales and prices to start rising again. A housing rebound would allow homeowners to refinance their current adjustable rate mortgages into fixed-rate loans with more affordable monthly payments.

The big sticking point in the negotiations was getting investors who purchased the mortgages, after they were bundled into mortgage-backed securities, to agree to accept lower interest payments. Critics have said even with a deal, there are likely to be lawsuits that could prevent the plan from taking effect.

Officials representing major players in the mortgage industry said they believed the plan would withstand any legal challenges and would help at-risk homeowners avoid defaulting on their mortgages.

Steve Bartlett, president of the Financial Services Roundtable, a trade group representing the country's largest financial service firms, said the deal would benefit banks, investors and homeowners since there is a significant cost when a mortgage is foreclosed.

Under the plan, the rate freeze will apply to loans made at the start of 2005 through July 30 of this year, and will cover loans that had been scheduled to rise to higher rates between Jan. 1, 2008, and July 31, 2010.

In theory, this is a great plan.

But in reality, according to research strategists at Merrill Lynch, the help will likely be marginal at best. The new guidelines address only borrowers who can continue to afford the initial teaser rates, but are likely to default when the rates reset.

Most of these buyers are probably already eligible for loan modifications and may already be in the process of beginning a workout with servicers, or even perhaps applying to a state-backed low income housing affordability program for refinance. So not much help here.

Many other categories of risky loans aren't included in the plan at this point, other analysts noted, including loans in which borrowers used "piggyback" home equity loans to finance a home purchase, and “no-documentation” loans.

Other borrowers left out in the cold include: Those who can afford a rate adjustment; those who are already behind on their payments; borrowers who hold option-ARMs that aren't subprime; those who can refinance into a fixed-rate loan; and those who bought homes as investments.

"Many government and policy makers feel this is a subprime problem, which is completely wrong," said Paul J. Miller Jr., a Friedman Billings Ramsey analyst. "The plan will not rescue the housing market."

Most of the news on the subprime meltdown focuses on problems borrowers face when their loans reset from low teaser rates to much higher fixed rates. While this is a big issue for millions of borrowers, resetting subprime mortgages is just a single wave in an ocean of bad mortgage debt.

Many of the subprime mortgages were seriously delinquent or in foreclosure long before the mortgages reset to higher rates.

The Federal Deposit Insurance Corp. found in an analysis done early this year that 10 percent of the subprime adjustable rate mortgages issued in 2006 were seriously delinquent, behind three or more payments, or in foreclosure within 10 months of issuance.

Since no mortgages had reset at the 10-month point, clearly there were other problems.

Either borrowers could not afford even the low teaser rates or they were defaulting because they realized that their homes were worth less than their mortgages.

The market value problem will only get worse as house prices continue to drop because of the housing market glut, and tightening credit hurts demand. The inventory of unsold new homes is 50 percent above the previous record, and the number of vacant ownership units is almost twice the previous peak.

In too many cases, defaults aren't the result of a reset. The mortgage was a huge stretch from the get-go, and all it took was a job loss or some other life change to push it over the brink.

Part Three - More Glicthes in the Treasury Secretary's Mortgage Bailout Plan