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Holes in the bailout

A proposal to ease the pain of those caught in the sub-prime mess may not help the true victims.

September 13, 2007

One of the most difficult questions posed by the sub-prime mortgage meltdown is who, if anyone, the government should be trying to help. First-time home buyers misled by mortgage brokers are more sympathetic than, say, borrowers or lenders who deliberately took on outsized risks, but it's hard to set rules that can distinguish between the two.

The challenge is brought into focus by each proposal emanating from Washington. The latest example is a bill introduced this week by Sen. Charles E. Schumer (D-N.Y.), the chairman of the Senate Banking Committee's housing subcommittee. Schumer would have two government-sponsored agencies, Fannie Mae and Freddie Mac, boost mortgage lending by letting them expand their sizable portfolios of mortgages and mortgage-backed bonds by at least 10%. Those portfolios, each of which is worth more than $700 billion, were capped by Congress in response to accounting problems at the agencies.

The caps shouldn't be lifted until Fannie and Freddie have cleared the last vestiges of accounting fraud and come under more rigorous oversight. And although Schumer's bill would help some lenders and borrowers, they're not necessarily the ones the government should be helping.

Beneficiaries would include some of the homeowners whose adjustable-rate loans recently jumped to a higher interest rate or are slated to do so soon. The bill would require Fannie and Freddie to use at least half of the new buying power to add those loans to their portfolios, which would help the borrowers refinance under better terms.

But Fannie and Freddie's strict requirements for loan quality would appear to stop them from rescuing buyers stuck with the most problematic sub-prime mortgages, such as those with high prepayment penalties or ever-mounting balances. As a result, help would go to the most creditworthy borrowers holding the least punitive loans -- along with their lenders. Nor would the measure distinguish between borrowers who were duped into accepting bad terms and those who had foolishly bet on an endlessly rising market for homes.

Schumer also would help borrowers in communities with unusually high housing costs, such as Los Angeles and New York. Home prices are so high in these markets, many mortgages are more than $417,000 -- the largest loan Fannie and Freddie are allowed to buy. Schumer proposes to raise that limit by up to 50% for one year.

That's a potential boon not just to middle-class home buyers but to home sellers in those markets -- in effect, it would help maintain the excessively high prices. Those buyers and sellers aren't the ones most directly affected by the sub-prime meltdown, though; rather, they're feeling the sort of pain that periodically spasms in the housing market. The Federal Reserve may have kept interest rates artificially low for several years, but that's no reason for Congress to spring into action when the rate for jumbo loans inches above 7%.

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