Bush unveils sub-prime bail-out plan to threats of legal action

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The Independent Online

American homeowners who took on mortgages they cannot afford will have their interest rates reduced to allow them to stay in their homes, thanks to a plan unveiled by President George Bush.

With foreclosures surging to record levels, according to figures out yesterday, the controversial plan is aimed at propping up the housing market and limiting the financial losses suffered by mortgage lenders and investors in mortgage-backed securities. However, the plan could trigger a wave of legal action from those investors, and there was also an angry reaction from many homeowners who have been diligently paying their mortgage bills.

"We should not bail out lenders, real-estate speculators or those who made the reckless decision to buy a home they knew they could not afford," Mr Bush said. "The homeowners deserve our help. The steps I've outlined today are a sensible response to a serious challenge."

The voluntary agreement is the culmination of weeks of talks between the Bush administration, the administrative companies which service the loans, and representatives of the investors who ultimately own the mortgages. Thanks to the spread of securitisation, most mortgages have been sold on by the lenders and parcelled up into derivatives such as mortgage-backed securities and collateralised debt obligations, meaning that their ultimate ownership is scattered among investors across the globe.

Hank Paulson, Treasury Secretary, admitted that some of these investors may be angry that the terms of the underlying mortgages are being modified, but pointed out that the American Securitisation Forum, which represents investors, was supportive of the plan. "The industry standards announced today do not change the nature of the responsibilities in the servicing industry servicers will continue to modify loans when it is in the best interests of the investors," he said. "With the investor community on board and as a clear beneficiary of this approach, the risk of litigation should be manageable."

Mark Adelson, of the securitisation consultancy Adelson & Jacob, said investors will wait to see how the plan is implemented. "If it is the servicers giving away someone else's money, then that is like stealing and that's horrible. If they are maximising the recovery of the loan, then that is in the loan-holders' best interests. The trouble is we can't tell in advance, only afterwards, when we find how many modifications fail, that is, how many people redefault. If investors see modifications happening that are just stupid, then I expect them to react to that."

Until the bursting of the credit bubble this summer, millions of Americans were able to take out home loans with low introductory "teaser" interest rates, hoping that they would be able to refinance before the rate reset to a higher monthly payment. Home foreclosures shot up to an all-time high in the three months to the end of September, the Mortgage Bankers' Association said yesterday, and the number of borrowers that have fallen behind in their payments is now 6 per cent. A Moody's economic report yesterday predicted that house prices will continue to fall while the market is "awash with unsold inventory", a problem that would be exacerbated if increasing numbers of foreclosed homes come on to the market.

A further 1.8 million loans will reset higher over the next two years. Borrowers who have been up to date with their payments so far will be allowed to keep paying the teaser rate for another five years while they are at risk of defaulting on the higher monthly payments, according to the new plan. The agreement is meant to introduce streamlined processes for assessing who should qualify for a bail-out, which might otherwise have to be negotiated on a case-by-case basis, potentially overwhelming the mortgage servicers. It is a nationwide version of a plan agreed between mortgage servicers and the governor of California, Arnold Schwarzenegger, last month.

Supporters argue that unscrupulous mortgage brokers foisted unsuitable loans on unsuspecting borrowers, in order to satisfy the demands of Wall Street for mortgages that could be parcelled up and sold on.

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