The Mortage Crisis: A Challenge to the U.S. Banking System?

I’m on record here as stating that the real estate/foreclosure/sub prime mortgage problem currently unfolding presents a potential crisis for the U.S. economy. Late breaking news on the subject on on Wednesday, however, makes me wonder if I’ve been too optimistic to date.

This entire situation has so many facets that it’s truly challenging to grasp them all, but this is the first time that I’ve been aware that the F.D.I.C. has been pulled into the fray.

Bush administration reaches mortgage deal

Under terms of an agreement hammered out between the administration and  lenders, interest rates would be frozen for five years on certain subprime mortgages, congressional aides said.

The plan apparently would not go quite as far as those proposed by Democratic presidential candidates Hillary Rodham Clinton and John Edwards, who are focusing on the issue in their campaigns. News of an agreement on the White House plan emerged just as Clinton was discussing her own proposal in a speech in New York and then an interview on CNBC.

The White House plan, the result of negotiations led by Treasury Secretary Henry Paulson, would freeze interest rates at lower “starter” rates on many loans that were popular with lenders and borrowers the tail end of the housing boom.

Clinton’s proposal also would impose a 90-day moratorium on foreclosures.

With home prices now falling in many parts of the country, many homeowners are having trouble refinancing their loans because they have little or no equity left — and may owe more than their home is worth.

Paulson, who has been leading talks with regulators, investors and lenders, said Monday that the government wanted to freeze rates to give homeowners and lenders more time to refinance or modify terms of existing loans. Bush is scheduled to speak about the plan at the White House Thursday, and Paulson will hold a news conference with Housing and Urban Development Secretary Alphonso Jackson to provide details. […]

The Treasury plan reportedly would include a five-year freeze on adjustable rates for borrowers with loans made from the start of 2005 through July 30 of this year with rates that are scheduled to rise between Jan. 1, 2008, and July 31, 2010.

Until recently, the White House has insisted that the task of modifying of mortgage loans should be handled on a case-by-case basis.  In October, Sheila Bair, head of the Federal Deposit Insurance Corp., suggested a more comprehensive approach that would involve freezing rates on loans that are scheduled set to move higher.

But foreclosure attorneys, regulators, mortgage brokers, credit counselors and others involved in helping homeowners head off foreclosures say the complexity of the process will make broad solutions difficult to implement.

The FDIC, of course, is the insurer of last resort for bank account balances up to $100,000. But the only way that accounts become at risk is in instances of bank failure. Banks cannot keep operating and just refuse to repay some or all depositors. Further, the FDIC actively monitors bank solvency to anticipate problems, and becomes proactive only in the event that a potential for loss is perceived.

According to the article excerpted, FDIC has taken an aggressive stance in reaction to the unfolding situation, resulting in proposing a systemic response. A systemic response on the part of FDIC, as I understand it, connotes a systemic problem. Certainly in instances of a problem with a particular banking institution the approach is to structure a response directed only to the problem.

Banks make relatively few mortgages for their own portfolio, that being the role primarily of secondary market securitizations. The thought that there might possibly be banking system exposure to the losses being displayed in the headlines with regards to some individual banks is not something that seemed to me before now to be an issue. However, if FDIC perceives this situation as being sufficient to warrant FDIC intervention at this level, that is a factor that merits attention by every concerned observer.

EDITORS NOTE: Info on Hillary Clinton’s plan is available here and the text of her remarks on Wall Street on the Housing Crisis is available here.

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