Bush Scheme for Lowering Home Mortgage Payments Could Trigger Credit Crunch

Washington, D.C., December 6, 2007—President Bush today week unveiled a plan to push financial institutions to "voluntarily" agree to freeze interest rates for adjustable-rate mortgages. John Berlau, director of CEI’s Center for Entrepreneurship warns against this ill-conceived scheme:

At the very least, if the Bush Administration plan is truly voluntary, it’s unnecessary. Loan holders and servicers have plenty of incentive to do that themselves. No one sitting in a central office can hope to set the right mortgage terms for millions of borrowers, lenders, and investors.

Like all so-called five-year plans, the five-year interest rate freeze by its design would pretty much have only negative effects and worsen the credit slowdown. While apparently no taxpayer dollars are directly involved (at least not yet), by pressuring the rewrite of millions of mortgage contracts, the Paulson plan could have even greater costs on the economy as well as future aspiring homeowners than even a direct taxpayer bailout. The credit market depends on the sanctity of contracts for everything from the financing of mortgages to new small businesses. But if regulators can negate contracts anytime there is a problem, much of this credit could dry up.

Right now, while foreclosure rates have significantly increased, the percentage of homes in foreclosure is still less than 1 percent, according to the respected National Delinquency Survey of the Mortgage Bankers Association. But the credit market is nervous because of housing market unpredictability and the flaws in methods it previously used for valuing mortgage-backed securities. The urge to "do something" by forcing the changing of contracts could make the credit market diminish even further.