Paulson told the audience, "There is much that Congress can do to help America's homeowners."

To qualify, borrowers must be current in their payments and show the ability to stay current at the intro rate. They would not qualify if they could afford the higher rate or could refinance into a fixed rate loan. The plan would require an analysis of borrowers' ability to repay by looking at their monthly income and other expenses.

The securities industry, Wall Street and the structured investment vehicles managed by fund managers would have to comply and cooperate for such a plan to become workable, and it may be unlikely they will do so absent a mandate of some kind. One burning question that remains unanswered is who will suffer the losses (or forego the increased payments). Because the plan is voluntary, mortgage servicers — who collect payments for investors — have no incentive to modify existing terms, and have expressed fear that if they do so, they will be liable through lawsuits challenging judgments made to prevent foreclosures.

"Mortgage market financial innovation has benefited the U.S. economy and U.S. homeowners; it has also introduced some of the challenges we face today," Paulson said. Financial innovation led to the creation of mortgage products that put homeownership within the reach of more people. "At the same time, innovation also made riskier loans — with no down payments or minimal documentation — more widely available. Similarly, securitization has brought benefits and challenges — making more capital available for mortgages, but creating greater market complexity. As a result, we now have an array of different market participants, often with different interests."

Other government efforts to stem the crisis include the Federal Housing Authority's FHASecure program, a part of the Dept. of Housing and Urban Development which allows refinancing options of delinquent borrowers with hybrid ARMs to move into fixed-rate loans. HUD secretary Alphonso Jackson stated recently that some 33,000 borrowers have already done so and that an additional 20,000 are in the pipeline for approval this month, making for a total of more than 53,000 since the program was initiated last August. Steve O'Halloran, HUD spokesman, estimated that it could help as many as a quarter-million by the end of 2008.

Congressional Hearings

Freshly returned from its Thanksgiving break, the House Financial Services Committee held a hearing, "Accelerating Loan Modifications, Improving Foreclosure Prevention and Enhancing Enforcement" on Dec. 6.

Chairman Barney Frank's (D-Mass.) opening remarks addressed the White House/Treasury proposal. Frank spoke about the relationship between borrower and lender. While supporting the new Administration proposal, Frank also took issue with its approach toward borrowers' FICO credit scores.

"I have always been told by bankers that the prime rule of banking was 'know your borrower,'" he said. "And what has happened is that we have created through a whole group of new methods a situation in which you not only don't know your borrower, you have no idea who your borrower's borrowers' were or are. The nexus between the borrower and the lender, I believe, turns out to have been a more important safeguard than we thought and we have been trying very hard, the private sector has, and some of us in the regulatory field have been trying to find a substitute for the borrower-lender relationship and we have, as it turns out, have been less successful than we thought."

"That is what risk management is. It is a substitute, it seems to me, for trying to know whether the person you lent the money to can pay you back. And what we need to do is to figure out not just in subprime but in general how to deal with that, and that will be the subject of further hearings: How do you keep the benefits of this increased liquidity and find some way to preserve again what has been the great safeguard of not lending money to people who you didn't think can pay you back."

"When you don't have to worry about whether they pay you back–and when the people who now own the loans don't know who in effect they lent it to ultimately–we have problems."

Frank said he welcomed the Administration's proposal as "a recognition that the increase in the rates would cause serious problems and that some public sector concern with that is appropriate, that the market cannot be left entirely on its own."

On the other hand, "I did tell Secretary Paulson in a conversation this morning in fact that there are a couple of problems that I have with this."

"First of all I think it is a grave error to say–as I understand the proposal does–that there is a cutoff at a 660 FICO score. Apparently people have thought that a FICO score credit rating was a good proxy for income. I don't think it is and I think we would be making a great mistake frankly, morally and also politically, if we tell two people who are otherwise similarly situated that the one who has been more careful about his or her credit is not going to get the benefit that people who have been more/less careful will. I think the 660 FICO score is a great mistake."

The Committee will hold a hearing entitled, The Financial Consumer Hotline Act of 2007: Providing Consumers with Easy Access to the Appropriate Banking Regulator on December 12.

California Strategy

On the West Coast, meanwhile, California Governor Arnold Schwarzenegger brokered a deal in November with that state's four largest lenders, including Countrywide, to continue low introductory rates on subprime ARMs.

Eva Weber, an analyst with the Aite Group, told Credit Union Times that "the California experiment has implications for the whole country and regulators will be watching closely, as shockwaves from a slumping mortgage market are bad news all around."

But Weber found it debatable that lenders would voluntarily keep rates frozen. "I just don't see it happening on a scale large enough." Again, details of what entities would lose out are unknown. "When mortgage are packaged and sold off money is paid and this buries the risk. Are those investors to be left out?" Weber asked. California has a high percentage of these kinds of loans, so the state is trying to stop the bleeding, and other governors and states may pick up on the idea. "But it's still just a small portion of the overall problem," Weber said.

Assembly Speaker Fabian Nunez asked for a legislative session to address possible reforms. "In the end, states may prove more nimble than federal regulators in passing mortgage reforms, but undoing the damage already done may prove more difficult," said Weber.

In the Keystone State, Secretary of Banking Steve Kaplan urged Pennsylvania lawmakers to pass stronger laws to protect borrowers against abusive lending practices and prevent foreclosures. He also urged passage of House Resolution 415, which would call on Congress to freeze existing mortgages and declare a moratorium on foreclosures. But he warned that any federal action would not prevent Pennsylvania from taking preventive measures of its own.

"So much depends on how lenders respond," said Weber. "Will they create a fast track or drag their feet, and will it be enough? That's the question. Congress will eventually have to do something. The problem is so large and wide-scale, but I don't see anything like an S&L bailout."

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