Let’s put a freeze on mortgage rate resets

The prospect of 2 million homeowners seeing their mortgage rates jump over the next two years as adjustable-rate mortgages reset, possibly triggering hundreds of thousands of foreclosures, has forced the government, lenders and the mortgage-servicing companies to focus on the problem.

Now it is possible to see the outlines of a solution.

Treasury Secretary Henry Paulson has persuaded the mortgage industry to freeze interest rates on some subprime loans — in particular, those on which the homeowner is or was making payments at the initial interest rate but is unable to afford the rate step-up.

Ironically, a freeze on interest rates on subprime mortgages may help thaw other parts of the capital markets. The freeze is to last up to five years, apply only to owner-occupied homes and continue only as long as the homeowner remains current on the mortgage.

Mr. Paulson and officials with the Department of the Treasury have been arguing for at least a three-year freeze; industry officials want a shorter one.

In a Sept. 3 editorial, InvestmentNews urged a five-year freeze to allow homeowners time for their incomes to increase enough so they could afford the higher rates or so that home values could recover enough to allow refinancing at a fixed rate. A one-year freeze merely would have postponed a long-term solution.

A voluntary, temporary freeze of longer duration has several favorable aspects. First, since no congressional action is needed, it can take effect once an agreement is reached.

Second, speculators — those who bought houses to flip quickly for gain — aren’t bailed out. They are still likely to default and lose their investments.

Finally, investors who foolishly invested in mortgage-backed securities that seemed to offer high returns at low risk will see the value of those securities decline.

A lengthy freeze no doubt will greatly reduce the number of mortgage defaults and help reduce uncertainty about the interest payments of mortgage-backed securities. This may set a floor under the value of the bonds and allow them to be traded freely again.

Part of the problem with the securities at present is that no one knows how many homeowners will default. Therefore, investors expect the worst and will buy the securities only at very deep discounts, if at all.

Reducing the number of foreclosures also would reduce the damage to the economy from the mortgage crisis.

A severe recession triggered by massive mortgage defaults and foreclosures would hurt investors far more than accepting lower returns on mortgage-backed securities for a few years.

Other steps being taken or considered include expanding by 200,000 the number of families qualifying for Federal Housing Administration mortgage insurance, increased funding for mortgage-counseling services and legislation temporarily relieving homeowners of the obligation to pay taxes on mortgage debt forgiven by lenders.

All these are necessary and should be pushed through Congress as quickly as possible.

But a temporary freeze on mortgage rates is the first key step. Let’s get the mortgage-backed-securities market unfrozen, and with it the mortgage and real estate markets.

After the crisis has passed, we can explore steps to ensure that the errors that led to the subprime- mortgage crisis are not repeated.