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The Terminator and Unintended Consequenses

Written By Brian Hicks

Posted November 21, 2007

I must admit that when I first heard about Shelia Bair’s, neat-o little suggestion about a month ago that the only way to correct the problem in sub-prime adjustable rate mortgages was to fix them all at their starter rates, It kind of blew me away.

Not for its genius-mind you-but for its cluelessness.

"Keep it at the starter rate," the FDIC chief said then. "Convert it into a fixed rate. Make it permanent. And get on with it."

I mean the whole idea was so preposterous on the face of it that I practically fell out of my chair laughing when heard it.

Sure, I thought, just give everyone a 2% fixed rate and call it even. Then we could have one of those "Mission Accomplished" photo-ops and all go home early.

But this morning I have finally had to stop laughing about it because her suggestions have actually been picked up and implemented by the Terminator himself-Governor Schwarzenegger of California.

From the Office of the Governor: Gov. Schwarzenegger Works with Lenders to Help Homeowners Avoid Foreclosure.

"With California impacted more than any other state by the national home foreclosure crisis, Governor Arnold Schwarzenegger worked with loan servicers from Countrywide, GMAC, Litton and HomEq to agree to streamline "fast-track" procedures to help keep more subprime borrowers in their homes. Together these four enterprises service more than 25 percent of issued subprime mortgage loans.

The agreement the Governor negotiated with lenders builds off a proposal put forward by Federal Deposit Insurance Corporation Chair Sheila Bair that encourages lending agencies to keep subprime mortgage borrowers at their initial interest rate if they are living in their home, making timely payments, but can’t afford the loan "re-set"–or jump to a higher rate."

So what’s wrong with helping to keep some people in their homes by "fixing their rates" you ask?

Well, aside from the obvious moral hazard (rewarding the foolish), any governmental action that magically makes adjustable rates fixed completely calls into question the validity of contracts-which to a great extent is one of the essential bedrocks of doing business.

And when you weaken even slightly  the ability to enforce a contract; it puts you entirely on the slippery slope. That’s true even if your intentions are admirable.

I mean what good is a contract really between two parties, if it can essentially be torn up and thrown away years later by the borrower with a little help from the government?

The answer, of course, is not much.

And if that is the case, why would anyone in their right mind even offer an adjustable-rate mortgage anymore if it could be tossed aside later to score political points?And moreover, what investor would buy one?

So while Governor Schwarzenegger may have helped a few folks keep their homes today, he has also stepped knee deep into the land of unintended consequences-big time.

This is one judgment day that can’t be avoided.