A Subprime Idea from the FDIC

There's an inventive and potentially good idea from the FDIC's Sheila Bair in today's NYT, which should be added to the Baker-Samwick proposal as another weapon in the arsenal being lined up to fight the worst effects of the housing crash.

Bair's thesis rests on two lemmas, neither of which is trivially true but both of which are more true than false. The first is that for the servicers of subprime loans, "renegotiating terms loan by loan is too costly and time consuming" – so they don't, which hurts both homeowner and lender. The second is that the teaser rates on 2/28 and 3/27 subprime ARMs are invariably higher than prime rates today.

If those two assertions really are true – and I'm not nearly enough of an expert to judge, but it's worth assuming that Bair knows what she's talking about – then her plan makes some sense. If a subprime borrower with a 2/28 or 3/27 runs into trouble as a result of her reset, then there should simply be a standard restructuring, converting the loan to a fixed-rate mortgage at the starter rate.

This is far from being a perfect solution. It rewards the foolhardy borrowers who plumped for the lowest teaser rates over those who ensured that they could afford their mortgage payments indefinitely. It also encourages pretty much anybody with a subprime ARM to default on a mortgage payment or two, which can't be a good idea.

But I do like the idea of a standardized restructuring which can be easily implemented by overworked servicers and which doesn't need much if anything in the way of regulatory action or legislation. If a lender thinks this proposal will save it money, then it can instruct its servicers to implement it. (Assuming that all the problems with securitization of the loan making it hard to restructure do get ironed out, and I hope that they will.) There's actually no need for any lender or servicer to wait for other playeres to sign up: if this proposal makes sense for everybody, it makes sense for anybody unilaterally as well.

Which is not to say that I'm hopeful this will happen. The mortgage industry, as we've seen, is a supertanker, and getting any changes at all – let alone something as radical as this – will be very difficult.

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