Monday, October 8, 2007

FDIC says, cancel interest-rate adjustments

It sounds a little off to me, but that’s the next brilliant bailout idea: modify loans that are about to adjust and “freeze” the interest rates. This is exactly what FDIC’s (Federal Deposit Insurance Corp) Chairman Sheila Bair asked lenders to do. Naturally, the changes should only affect “good” borrowers who occupy their homes, are current on their payments and own adjustable mortgages that haven’t reset yet.

However, surveys show that only a fraction of the ARMs scheduled to adjust in the coming months get modified, partly because of restrictions in the servicing agreements that limit the number of loans that can be modified. Investors who own the loans are unwilling to allow modifications because this will cause mortgages and the securities backed by them to lose value.

OK, ARMs were designed to adjust at some point, that’s their essence. Converting them to fixed home loans is against the rules – after all, they were marketed as a bet against economic fundamentals and market conditions that affect interest rates. And if a large number of ARMs do somehow get modified, who knows what may happen next? More troubled hedge funds? More credit rating downgrades? Elimination of all types of ARMs? I don’t think this is the solution yet.

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