Of all the ideas floated to help solve the subprime mess, I never really believed
that Sheila Bair’s plan to simply lock in teaser rates would be the
one to gain traction. As I
said when it was first mooted, it has some major weaknesses:
This is far from being a perfect solution. It rewards the foolhardy borrowers
who plumped for the lowest teaser rates over those who ensured that they could
afford their mortgage payments indefinitely. It also encourages pretty much
anybody with a subprime ARM to default on a mortgage payment or two, which
can’t be a good idea.
But that was well over a month ago. Since then, the plan has obviously been
refined to take those obvious objections into account, right? Right? Er, not
so much. In fact, in an echo of the still-not-launched Superconduit, this idea
seems to have found its way into the press with most of its details still to
be worked out.
I trust that someone, somewhere, is looking into the effect that this might
have on securities prices. The WSJ treats bondholders as some kind of homogenous
mass:
Among the holdouts have been investors, who typically hold securities backed
by mortgages. If interest rates are frozen, they would lose the potential
benefit of higher payments. But investors have cautiously moved toward cooperation,
likely on the grounds that it’s better to get some interest than none at all.
In reality, it’s almost certain that some bondholders would benefit from this
scheme, while others would lose out. My intuition is that the plan would help
out junior bondholders at the expense of senior bondholders, although it probably
differs on a case-by-case basis.
I also hope that Treasury has looked in some detail at the qualification mechanism
for this scheme, which could carry a host of unintended consequences. That said,
something very similar has already been launched
in California, so I hold out a tiny hope that someone, somewhere, has done some
degree of due diligence on the way these plans are constructed. The last thing
anybody needs right now is a whole new wave of tactical delinquencies designed
to bring loans into the qualification zone.