Implementing the proposed bailout of subprime borrowers who face foreclosure may be so difficult that it will turn out to be no better than the loan modification efforts already underway, analysts said.
The plan, spearheaded by Treasury Secretary Henry Paulson, seeks to freeze teaser interest rates for homeowners who are current in their payments, but who would default after the rate resets higher. As floated, the plan would exclude those deemed to have the financial ability to meet higher payments.
Separating those is a laborious process that will be costly for lenders and open to gaming by homeowners seeking the relief that could save them thousands of dollars each year, analysts said.
It will be a 'Very Big Challenge' to segregate these borrowers, Paul Miller, an analyst at Friedman Billings Ramsey in Arlington, Virginia, said in a research note on Tuesday. Working through loans on a case-by-case basis will take time and be expensive, he said.
The plan, dubbed Teaser Freezer, is thus more hype than substance, Miller and colleagues wrote.
Loan modifications by major lenders have been growing at a snail's pace, prompting increased calls for a larger response from regulators and the Bush administration. Freezing rates, which is a key to most modifications, for all adjustable subprime loans probably proved unworkable for the plan authors, Friedman Billings Ramsey said.
Richard Syron, chief executive officer of the second-largest home financing company, Freddie Mac (FRE.N: Quote, Profile, Research), held back full support for the plan in a CNBC interview since it is still not known how borrowers would be chosen.
Legal issues have stalled modifications to date and may also limit the plan's effectiveness, economists at Goldman Sachs Group Inc. said in a note dated Monday. Most of the subprime loans created in recent years are locked up in bonds that are governed by contracts between investors and loan servicing companies, they said.
Forecasts that foreclosures could soar to levels and push the economy into recession next year scared the government into action, Miller said. Payments will rise next year on about 2 million subprime loans worth $350 billion, said the Friedman Billings Ramsey analyst.
Miller and other Wall Street analysts say that easing resets -- as troublesome as they are -- will not solve the root of the problem. Too many homeowners, from prime to subprime, were allowed loans for the full price of a home during the housing boom, leaving them vulnerable as the housing bubble deflates.
Half of all modifications end up as redefaults, suggesting that the process only delays the inevitable, Miller said.
We expect losses will continue to rise until home prices stabilize, which we expect to take another four to six quarters, Miller said.