Last week, the Bush Administration introduced its highly anticipated plan to save borrowers who purchased their homes with adjustable-rate subprime mortgages from losing their homes, and to stem the tide of rapidly falling home prices.
Unfortunately, and in direct contrast to Treasury Secretary Henry Paulson's comment that "nobody gets hurt" by the Bush mortgage plan, my research indicates that many people will be harmed by the bailout, and that home prices will continue to fall in spite of it.
U.S. equity markets have reacted positively to the Bush plan over the past two trading days. Nevertheless, the bond markets have responded negatively.
For those of you who haven't reviewed the Bush plan, here are the details:
The plan, which is really nothing more than a series of suggestions to lenders, is completely voluntary — mortgage lenders are not required to implement its suggestions.
If lenders follow the plan's guidelines (that is, the suggestions), subprime mortgage borrowers who qualify under the guidelines might be able to convince their mortgage lender to freeze payments at the introductory "teaser" rate for up to five years.
Lenders will determine who qualifies by evaluating a set of criteria, which include credit scores, income, and payment history
Here are the suggested qualification standards for borrowers:
They must have signed an adjustable-rate mortgage agreement between Jan. 1, 2005, and July 31, 2007.
Making mortgage payments on time.
Borrowers must demonstrate to their lender that they can't afford the higher interest rate due when their adjustable-rate mortgage resets between Jan. 1, 2008, and July 31, 2010.
Subprime mortgage borrowers who convince their mortgage lender to follow the plan's guidelines might be granted an option to refinance into a new mortgage or switch to a loan insured by the Federal Housing Administration.
The Bush mortgage plan excludes people who have been more than 60 days behind on their payments during the past year and those with less than 3 percent equity in their home at the time the loan was made.
The Bush plan is a façade. The only likely positive outcome that might materialize from the plan — if the media "talks up" the supposedly positive aspects of the plan — is that consumer confidence in the economy might improve somewhat over the near-term.
If consumers' outlook does improve, enough of them might spend heavily enough at the malls over the next couple of months to provide for a potential increase in economic growth over the next few months.
There are, however, big risks.
Long-term interest rates, including rates on new mortgage loans will likely rise significantly over the coming year as a result of the attempted subprime bailout.
Meanwhile, home values will likely continue to fall, as only a small number of subprime "homeowners" (they own nothing; they are mortgage holders) will likely qualify for the Bush-plan's suggested freezing of their mortgage's "teaser" rate.
Hence, the number of home foreclosures will likely continue to rise over the coming months, and the glut of unsold new homes on the market, which are currently at their highest level in seventeen years, would rise.
The growing inventory of homes for sale will therefore cause home prices to continue to fall. Aggregate consumer spending a few months down the road would then decline.
Nothing about this plan changes my mind about the medium term outlook for the markets. I suggest for you to invest in defensive sectors of the market and to invest in ETFs that sell short the major stock market indices.
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