WASHINGTON (Reuters) - Mortgage industry executives worked on Saturday to hammer out details of a homeowner rescue plan that would freeze interest rates on some U.S. subprime mortgages for up to seven years, but questions remained over how to avoid investor lawsuits and other legal challenges.
The negotiations among lenders, servicers, investor groups, regulators and other parties were aimed at allowing U.S. Treasury Secretary Henry Paulson to announce a framework for the plan on Monday, with full details expected on Wednesday, said a mortgage sector source involved in the talks.
Paulson on Friday said the mortgage industry was working with the Treasury on a broad plan to help save the homes of subprime borrowers with adjustable-rate mortgages who cannot afford higher payments as their interest rates reset in coming months, but who otherwise could afford to stay in their homes.
The plan’s details are now up to the mortgage industry and investors, the two groups that will have to absorb its costs.
“The message is that everybody has to get on the bus,” the source said of Paulson’s directive.
Details over which mortgages would be considered for an automatic interest rate freeze of five to seven years are still sketchy. The source said that initially, only subprime loans with two- or three-year periods of low “teaser” rates would be considered, but more traditional subprime loans with longer fixed-rate periods could also be modified.
A shorter freeze period was initially considered, but Federal Deposit Insurance Corp. Chairman Sheila Bair pressed in the negotiations for a five- to seven-year freeze. Bair was the first federal regulator to propose a broad rate freeze as California negotiated a similar deal with several top mortgage lenders in the state, hard-hit by the housing downturn.
Estimates of mortgage resets vary. Federal Reserve officials estimate that 2 million mortgages face resets and as many as 500,000 of these could lose their homes.
Deutsche Bank said in a report on Friday that the population Paulson’s plan is aimed at -- owner-occupants with at least some equity and facing their first reset -- comprises 1.2 million loans valued at $258 billion, or one third of outstanding “first-lien” subprime loans.
A particularly thorny problem is the threat of lawsuits from investors who bought securities backed by the mortgages. These investors were promised a certain yield, based on the expected hikes in interest rates, and an automatic freeze without reviewing individual loans may give them grounds to sue mortgage servicers.
“You might end up benefiting borrowers who are perfectly capable of making payments,” said Ajay Rajadhyaksha, head of fixed-income strategy at Barclays Capital in New York. “I’d be surprised if every investor out there agreed to give servicers carte blanche” to freeze interest rates, he said.
Mortgage servicers asked for support from federal regulators, including the Office of Thrift Supervision and the Office of the Comptroller of the Currency, to help them deal with any legal backlash.
The American Securitization Forum, a trade group that represents large mortgage investors such as pension and mutual funds, said on Friday it could “support loan modifications in appropriate circumstances.”
A streamlined approach to loss mitigation “will ultimately help servicers manage their responsibilities in a changing market, while appropriately balancing the interests of borrowers and investors,” Tom Deutsch, ASF deputy executive director, said at a housing hearing in Los Angeles.
While agreeing on mortgage changes on a large scale is difficult, it has been done before. After Hurricane Katrina in 2005, for instance, housing finance giants Fannie Mae and Freddie Mac provided prolonged forbearance that let devastated Gulf Coast homeowners miss loan payments.
“This comes up every few years -- a tornado in the Dakotas or flooding somewhere. We would be able to modify the loans a bit. The investors hated it but the politicians loved it,” said a source familiar with how Fannie Mae and Freddie Mac have made allowances for stressed communities in the past. “It’s not easy, but it can be done.”
As major investors in subprime mortgages, the government-sponsored housing enterprises will need to be on board with the plan, but they face tight legal restrictions on how they can modify loans.
“We believe that any efforts by Treasury, originators, servicers and investors to help families in distress weather the current downturn are welcome and positive developments,” Freddie Mac said in a statement. “We are not familiar with all the details of this concept. But we believe it is critical for all parties to be creative in finding solutions to the current problems.”
(Additional reporting by Al Yoon in New York, editing by Eric Walsh)
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