Economics Tricks

The White House has recently unveiled a plan to help mitigate the wave of foreclosures that have recently swept the US as reports continue to predict that an even greater number (some estimate as much as 2 million) of Americans are likely to default within the next year.

This plan involves the major US lending companies making an agreement to freeze the relatively low "teaser" interest rates that many Adjustable Rate mortgages are set up with, instead of allowing them to reset at their regular time, usually two years from the loan's issue.

These subprime loans have an artificially low introductory rate of between 7 and 9 or more after the grace period, which many real estate owners have been unable to cope with in recent months, sending shockwaves through global markets as investors in mortgage-backed securities have been spooked. As their loans have defaulted, the bonds that have been repackaged and sold have become basically worthless. Bush's talks with mortgage companies have been concerned with solving both aspects of this problem by extending the introductory rates to a select cross-section of subprime borrowers, thus preserving some of the cashflow supposedly guaranteed to those investors who believed the AAA bond rating for the securities into which these mortgages have been sold off. Since the cost of a foreclosure is often over $50,000, the investors have little choice if they want to salvage any of their investment.

However, the standards used to judge which borrowers qualify for the rate freeze have been left (some say intentionally) vague. They have stated that those who are already in danger of default will be given no assistance, as well as those who can afford to pay their mortgages at the increased rates. What is unclear is how the lenders will determine who is able to pay. Those who fall into the middle bracket, or who are likely to default at some point if rates increase but who are able to make their payments now, are the targeted borrowers for the freeze, which is proported to last from two to five years past the date at which the rate would normally reset. Therefore, some foreclosures are still guaranteed, but the specter of falling property values, which threaten to send the entire US economy into a tailspin, will hopefully be offset somewhat.

Many economists have recognized the mortgage-related woes as a necessary reassessment of the American economy. In combination with the falling dollar, recent developments in this crisis make it clear that the housing market of the US has artificially inflated for years, which would have to be corrected somehow anyway. And, while this scenario is relatively unpleasant, the US has had unsustainably high levels of consumer spending, coupled with the lowest percentage of consumer saving in three decades. These statistics point towards a reckless tendency of many Americans to spend because the economy will always grow. While this assumption has helped industrialize the world through American spending, it may do harm in the long run. With any luck, the real estate landing will be softened and Americans will be more apt to work with their lenders. If not, it may just encourage more recklessness by the government's taking responsibility for the market's woes. Only time will tell.