Paulson said the plan will not be a government-run bailout of subprime borrowers, and the banks that loaned them money. Instead, Paulson said, the government is just providing an industry-sponsored solution to borrowers who can afford to own a home but would have trouble making their mortgage payments after a reset.Once upon a time their were three families who both bought a home June of 2006. The families were identical in every way. They had the same credit rating, the same amount of debt, the same income, the same number of kids. For all practical purposes they were mirror images of each other, except for one thing...
'This is not a government subsidy that we're talking about here,' said Paulson.
'This is something that the industry will do where it makes sense.'
The plan would establish guidelines for lenders to freeze payments for homeowners who qualify for the program. Paulson said the program would be completely voluntary, and only some borrowers would qualify.
He said homeowners who can handle an increase in payments and those who don't 'have the financial capability to own a home' will not be offered an interest-rate 'freeze. [emphasis mine]
The first family decided to buy a 3 bedroom, 2 bathroom starter house in a decent neighborhood using a fixed rate interest loan which they were able to get because they had been saving up for a down payment for several years. They made sure to take out a loan that they could afford and because they already had some built in equity, they weren't to worried about the housing market.
The second family decided to buy a 4 bedroom, 3 bathroom executive home in a great neighborhood. They did take out an adjustable rate loan, but they weren't to worried since they made sure that the house wasn't so expensive that they couldn't afford the reset if for some reason they were unable to refinance in a couple of years. It would be tight, but they figured they would be ok, especially since their payments were exactly the same as the first family and they had a bigger and better house.
The third family decided to buy a 5 bedroom, 3 bathroom McMansion instead. They knew they wouldn't be able to afford to the reset, but figured what the hell, they would always be able to refinance, because after all "housing prices always go up." They can afford their current payment, but it is tight.
Multiple Choice Question: Which family will soon get a helping hand?
The first family is living within their means, they made good decisions, and are financially sound... they won't be getting anything from the government.
The second family is still OK. They might be overstretched, but at least they were smart enough to make sure they could afford the reset. The government doesn't give a crap about them either.
The third family is living it up, living far and above their means. Yes... this family will be getting a helping hand from President Bush and the rest of the crooks that run the predatory mortgage companies.
Can you say Moral Hazard?
Moral Hazard is the prospect that a party insulated from risk may behave differently, for example, that an insured party's behavior will be more risky than it would without the insurance. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.