Late last year, the Treasury Secretary orchestrated a bailout of some subprime borrowers with adjustable-rate mortgages. Under it, their interest rates, which are slated to rise after the expiration of introductory low rates, would be frozen to keep their monthly payments low enough for them to afford.
That effectively rewarded some of them for their irresponsibility in buying more house than they could afford and gambling that interest rates would not rise substantially after their home purchase.
In The Richmond Times-Dispatch, professors of economics and law have a better solution: temporarily cut only borrowers’ payments, but not their interest rates, reducing the amount of money spent monthly on paying off principal (or eliminating it altogether to the point of negative amortization), without effectively writing off part of their debts through an interest rate freeze.
That would prevent a flurry of foreclosures and downward spiral in the housing market, without rewarding borrowers for their own lack of foresight.
It would also avoid another negative side effect of mortgage bailouts: fear among lenders that if they make loans, the government will later pressure them to rewrite those loans to protect borrowers from their own foolishness — a fear that could harm borrowers and the economy in the future, by leading to housing loans drying up, and to lenders increasing the interest rates and costs on their future home loans to protect against the risk of government meddling. (Government credit regulations tend to make borrowing more expensive, not less, for borrowers over the long haul).