U.S. regulators welcome subprime plan, urge caution

WASHINGTON (Reuters) - Freezing mortgage rates for five years could spare many struggling homeowners from default, bank regulators told Congress on Thursday, but one warned the deal might drive away investors who provide credit for lending.

With foreclosures at a record level, President Bush unveiled a plan on Thursday to modify mortgages. The deal is aimed at helping many of the 2 million homeowners who took out adjustable rate loans with relatively low "teaser" rates that are scheduled reset sharply higher. For details, see

"I anticipate this five-year term will give the vast majority of those who have been modified to refinance out into something lower (costing)," Sheila Bair, chairman of the Federal Deposit Insurance Corporation, said in response to questions from the House of Representative Financial Services panel.

Bair and other banking regulators testified on the mortgage crisis that has led to tighter credit conditions and is threatening broader damage to the U.S. economy. They appeared just before the president announced the plan, which comes as officials fear 500,000 Americans are at risk of losing their homes as $367 billion worth of adjustable-rate mortgages jump to higher interest rates in 2008 and 2009.

However, another bank supervisor warned at the hearing that the plan must be implemented with care to avoid damaging future investment.

"We all agree that modifications can benefit investors as well as borrowers if it is less costly than foreclosing," Comptroller of the Currency John Dugan told the lawmakers.

"I think the question is if you were to do it in a way that cut some investors off from lawsuits, you have a different set of concerns by investors. Some investors will say that this kind of modification does not benefit me ... and I'm never putting my money in this kind of thing again," he said.

Federal Reserve Governor Randall Kroszner said at the same hearing that as rates reset to higher levels, delinquency rates will rise in a deteriorating housing market that removes the options of selling or refinancing.

"In the past, many borrowers experiencing these resets were able to avoid the payment increases by refinancing their mortgages," he said. "The recent declines in house prices and the current tighter credit conditions, however, reduced the viability of this option for significant numbers of borrowers."

But he also urged caution in how loans are modified to ensure that legal rights are protected and access to credit is not impaired down the road.

"Changes to existing terms, however, should not be made lightly, should be consistent with safe and sound lending practices, and should not be made when they are only delaying losses to investors and consumers," he said.

Kroszner said that through the end of 2008, approximately one in 10 borrowers who hold such loans is scheduled to experience a reset, he added.

Standardized approaches to loan modification and other assistance to borrowers will help reduce uncertainty and help markets function smoothly, Kroszner said.

The Fed governor said the central bank is readying rules aimed at curtailing misleading mortgage advertising, requiring earlier disclosure of loan details, and combating unfair or deceptive lending practices.

(with additional reporting by Alister Bull, Patrick Rucker; Editing by Tom Hals)