By Alison Vekshin
Dec. 5 (Bloomberg) -- Federal regulators and U.S. lenders agreed to freeze interest rates on subprime mortgages for five years to stem rising foreclosures, said a person familiar with the measure.
President George W. Bush will announce the accord tomorrow, which was negotiated by officials including Treasury Secretary Henry Paulson. Paulson will hold a press conference tomorrow at 1:45 p.m. in Washington to discuss the plan, Treasury said in a statement.
``Fixing the reset period is an important action, and it's good that everyone now seems to be pushing in the same direction,'' said Michael Barr, a professor at the University of Michigan Law School and a former aide to Robert Rubin, who was President Bill Clinton's Treasury secretary from 1995 to 1999. ``Now the question is what additional steps are required to keep people in their homes and avoid foreclosures.''
Paulson finalized the deal as the housing recession entered a third year, threatening the economic expansion.
More than 30 percent of borrowers with subprime adjustable- rate mortgages are behind on their payments before their loans reset higher and 775,000 homes with $143 billion of mortgage debt will go into foreclosure over the next two years, according to estimates from analysts at Credit Suisse Group.
The freeze may apply to mortgages issued between January 2005 and July 2007 that are currently scheduled to reset between January 2008 and July 2010, said a person who has seen a draft proposal. Borrowers whose credit scores are below 660 out of a possible 850 and haven't risen by 10 percent since the loan was issued will be given priority.
Those with scores above 660 will be more closely scrutinized to determine whether they are eligible or must continue making payments under existing terms, said the person.
Officials and company executives spent much of the past week negotiating over how long to extend starter rates on subprime mortgages, which are usually given to people with poor or incomplete credit histories.
Most U.S. banks use FICO credit scores, a product of Minneapolis-based Fair Isaac Corp., to judge a borrower's ability to repay loans. Scores are correlated to interest rates banks are willing to charge.
Paulson briefed House Republicans today on the plan in a meeting in Washington.
Representative Adam Putnam of Florida, the chairman of the House Republican Conference, said yesterday his interest in Paulson's efforts rose since he got calls from Florida officials about a state investment pool for local governments hit by debt downgrades. The state board froze withdrawals Nov. 29 to stem a run on assets. Rising mortgage defaults spurred billions of dollars in losses on securities backed by the loans.
``Florida in general increases my thinking that we need to look at the reasons to help mitigate the subprime meltdown,'' Putnam said.
Other Republicans expressed skepticism today.
``My biggest concern is that there are a lot of Americans who are making their mortgage payments, they are current, and the benefit won't go to them,'' Representative Spencer Bachus, the top Republican on the House Financial Services Committee, told reporters after the meeting with Paulson today.
Democratic Senator Hillary Clinton of New York, a candidate for her party's presidential nomination, reiterated today her support for a five-year freeze. Speaking at New York's Nasdaq stock exchange, she said ``Wall Street helped create the foreclosure crisis, and Wall Street needs to help us solve it.''
One challenge will be to craft a deal minimizing lawsuits from investors in bonds backed by the mortgages being rewritten, analysts said. The longer that lower rates are extended, the more risk posed to the bonds' values. Republican Representative Mike Castle of Delaware has proposed legislation offering a ``safe harbor from legal liability'' to mortgage servicers.
``Within the contracts, there is room for the servicers to work with borrowers to minimize the loss for the investor,'' said Wayne Abernathy, executive director of financial-institutions policy at the American Bankers Association in Washington and a former Treasury assistant secretary.
About 100,000 subprime loans will jump from their discounted initial rates every month for the next two years, UBS AG estimates. American home foreclosures almost doubled in October from a year earlier as subprime borrowers failed to make higher payments on adjustable-rate mortgages, Irvine, California-based RealtyTrac Inc. said on Nov. 29.
Extending Starter Rates
These mortgages usually begin with a rate of 7 percent to 9 percent and then reset to between 11 percent and 13 percent. ``What we are talking about is having these loans modified, so they continue for a longer period of time at the starter rate,'' John Reich, director of the Office of Thrift Supervision, said in an interview in Washington Dec. 3.
Treasury spokeswoman Jennifer Zuccarelli declined to comment on specifics of the proposal.
Paulson and Fed Chairman Ben S. Bernanke are concerned that falling home values will choke consumer spending, which has driven economic growth since the last recession ended in 2001. By heading off further deterioration in the $11.5 trillion mortgage market, officials are also aiming to stem losses on securities backed by subprime loans.
The Bush administration's efforts to forge an agreement have become more urgent as the economy falters after a third-quarter spurt. Growth may cool to an annual rate of less than 1 percent in October to December, economists say, following an expansion of 4.9 percent in the prior three months.
No `Silver Bullet'
``The number of subprime-mortgage resets is going to increase dramatically next year, and we need to make sure the capacity is there to handle it,'' Paulson said in a speech at a Dec. 3 housing conference in Washington. While no ``silver bullet,'' rewriting a set of subprime loans would ``clearly'' ease the risks from the housing slump, he said in an interview.
Sheila Bair, chairman of the Federal Deposit Insurance Corp., has been working with Paulson and said she favors extending introductory rates for between five and seven years.
Fannie Mae Chief Executive Officer Daniel Mudd told reporters at the OTS event that a cap of at least two or three years ``seems to make sense.''
Paulson said in his speech that the government is focused on helping subprime borrowers who can afford the introductory mortgage rate but not the adjusted one. The plan ``does not, and will not, include spending taxpayer money on funding or subsidies for industry participants or homeowners,'' he said.