This is an interesting story from the WSJ.com:
"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... The plan is being negotiated between regulators including the Treasury Department and a coalition of mortgage-related companies including Citigroup Inc., Wells Fargo & Co., Washington Mutual Inc. and Countrywide Financial Corp. People familiar with the talks say the individual members have agreed to follow any agreement reached by the coalition, which is called the Hope Now Alliance."
"Details of the plan, which could be announced as early as next week, are still being worked out. In general, the government and the coalition have largely agreed to extend the lower introductory rate on home loans for certain borrowers who will have trouble making payments once their mortgages increase.
Many subprime loans carry a low "teaser" interest rate for the first two or three years, then reset to a higher rate for the remainder of the term, which is typically 30 years in total. In a typical case, the rate would rise to around 9.5% to 11% from 7% or 8%. That would boost an average borrower's payment by several hundred dollars a month."
This raises a lot of questions. The credit derivatives based on these loans will now face lower payments. If market rates float higher, and these mortgages and contracts are forced downward, how will they effect valuation? Will the insurers be on the hook for the difference? How exactly do you determine who gets the rate freeze, and who doesn't? Moral hazard is imminent. Some will be better off falling behind to get the rate freeze, or will they.
"Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups: those who can continue to make their payments even if rates rise, those who can't afford their mortgages even if rates stay steady, and those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates. Only the third group would be eligible for help.
The creditors are likely to look at whether the borrowers have equity in their homes, despite falling house prices, and whether their incomes are holding steady."
"Mr. Paulson, who is philosophically opposed to federal meddling in markets, at first rejected a sweeping approach to loan modifications when the idea was floated by Federal Deposit Insurance Corp. Chairwoman Sheila Bair. But he shifted his position recently. He told The Wall Street Journal last week that it would be impossible to "process the number of workouts and modifications that are going to be necessary doing it just sort of one-off.""
I think he has a point. Furthermore, what about those who took loans that they knowingly just couldn't afford. Normally, the market would shake them out. Now, it won't necessarily do so. I think they should just focus on those who were fraudulently led into mortgages that were not in their best interests. Those are the people you want to save, not the ones who tried to get a McMansion on a starter home budget, and got caught in a bind that they should have seen coming.