The federal government and several large mortgage lenders have a plan to freeze loan rates for certain subprime borrowers. The Wall Street Journal writes that ‘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."

Among the financial institution who will be on board are Citigroup (C), Countrywide (CFC), Washington Mutual (WM), and Wells Fargo (WFC). The government and these banks are worried that, as subprime adjustable-rate mortgages reset, interest rates on them could move from 7% to as high as 11.5%. That could certainly accelerate the rate of foreclosures.

The plan is fraught with problems. Which subprime borrowers will qualify? Will hundreds of thousands of homes have to be re-appraised? If so, who will cover those costs? Will there be a household income component to deciding who gets the special deals?

The other major trouble with the whole scheme is that it leaves out higher income homeowners who took out loans in good faith but will also see them reset in the next two years. These borrowers could argue that they were pulled in by super-low rates that will move up. The plan does not address what happens if this group cannot afford to stay in their homes.

There may be people classified as millionaires, simple working folk who have done well enough to own a 20 foot fishing boat and a four bedroom house in a nice suburb, who won’t be able to make their payments if they go from $3,000 a month to $6,000. That may seem odd, but the extra $3,000 is probably well above that on an after-tax basis. An additional $40,000 a year can be a lot of cake, even for the upper middle class.

If the government and lenders are going to be big-hearted with the subprime crowd, the ought to look a little higher in the income chain.

Douglas A. McIntyre

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