Question about the Treasury Dept's efforts to freeze adjustable mortgage rates?

Question

I do not understand why the Treasury Department has to step in to negotiate the freezing of mortgages rates.

Why cant the banks/mortgage companies use their own discretion by doing it themselves?

You would think it would make good business sense to freeze the rate and having a mortgagee continuing paying the mortgage than having the loan forclosed altogether...

An explanation to why these companies are not already doing this would be helpful. Thanks.

Answer 1

Actually, none of the above are correct. The problem is a problem of timing, duty and risk.

Imagine that there is a real estate market in equilibrium, but facing a block of foreclosures in addition to normal supply and demand relationships. The foreclosures will add supply but will not alter demand for purchased homes. The foreclosed may look for rental housing or move, but they will not look to purchase since they will not be eligible.

Since this is a serial process dependent upon liquidity available and the public does not know the magnitude nor timing of the foreclosures, so prices will fall month after month. Therefore there is an incentive to be the first to foreclose since you will realize higher prices and lower losses on your loans.

This has a potential to create a rush to foreclose causing everyone to lose who is holding debt, raising homelessness beyond the ability of communities to manage, and triggering losses for the FDIC and PBGC. Further, it is bad for elected officials in an election year. Also, ordinary homeowners could find their homes non-marketable or marketable at very low prices. This will cause people to be inflexible in looking for employment making the entire economy less efficient, making profits lower, making wages lower, putting more strain on the credit markets.

Banks can use discretion, but each one individually must foreclose as quickly as possible unless an agreement can limit how much any one of them forecloses. A run to foreclose would be much like a run on the bank, everyone gets burned and no one gets what they want. If they can agree on a mechanism, they can go to shareholders with a good citizen stance, be able to fight the internal politics and if it is enforceable protect themselves from one another. Cheating is in everyone's interest so protection from cheating is very important.

Rate freezes only make sense if the Treasury can promise low rates, which would be the same as promising high inflation. This will cause the mortgages to be worth less in a real sense, but profitable in the nominal sense. Bondholders will get hurt, potentially alot, but the banks will be fine, the homeowners will be hurt less than otherwise and the politicians will get re-elected.

Answer 2

Is-it-5 above is probably right. But also, not everyone will be foreclosed on -- plenty of people will still make the payments, it's not like it's automatic that everyone who has a variable loan can't afford the increase. A mortgage company does the math and figures that by jacking up rates for those who pay, they'll come out ahead even if they have to foreclose on some others.

It's not a total lose when a mortgage forecloses. The lender just auctions the house to try to recoup the loan, and in many cases there will be private mortgage insurance to make up the difference.

Answer 3

The Fed adjusts the interest rates in order to stimulate the economy. It's an expansionary monetary policy aimed at increasing planned investment. What this means is that banks are able to lend out more money because the interest rate is lower and this is why banks cannot affect their own interest rates. Banks have control over what rate to give to people depending on how risky they view that person (how likely they are to get their money back) but the prime rate is essentially set by the Fed.

Answer 4

The banks have investors expecting to get a return on the investments.
If the government requires them to hold interest rates on variable mortgages, it allows the banks an answer to the investors as to why they are not collecting the highest possible profits on those mortagages.