Commentary: “Subprime Freeze” Generates More Questions than Answers

It’s tough for anyone who has had exposure to mortgage servicing and the secondary markets to comment authoritatively on U.S. Treasury Secretary Henry Paulson’s brokering of a plan for a so-called “subprime freeze,” where only a certain segment of subprime ARM borrowers are eligible for a loan modification that will see their notes restructured to stay at the teaser rate for some unknown period of time. That lucky certain segment? Subprime ARM borrowers who have not yet seen payments reset, who cannot afford a looming reset, and who are bad candidates for refinancing — in other words, most of the remaining fraudsters who haven’t already defaulted their way into the EPD history books. I’m just saying what most of us already know, or should know: even Fitch was forced to admit as much in their recent analysis of the 2006 subprime vintage. Is this really the group Paulson and Capitol Hill wants to target for assistance? (Will the mass modification strategy allow for strong and swift prosecution, too?) There are more questions, far too many to address: How do we determine “subprime?” How does a servicer determine “ability to repay?” How is that process any different from existing processes in place that determine “ability to repay?” Does getting a “rate freeze” require one-to-one contact with borrowers, and servicing personnel who will be tasked with supporting the categorization process? How do we tell an Alt-A ARM borrower that they’re screwed because they aren’t subprime enough? What happens to all of the Option ARMs outstanding when they recapitalize? What happens when the “bailed out” subprime borrower still can’t afford their mortgage after this supposedly temporary freeze thaws out? Will a rate freeze serve to extend the term of the loan to cover any shortfalls? Are we talking about forgiving principal or forgoing future interest? Whew. I could go on. It’s that complex. That being said, should this become reality, I can see this becoming a large nightmare for servicers even if a standard for modification is established and agreed upon — already strapped for resources due to a historic surge in defaults, servicers are now going to have to work with a large number of borrowers to execute a freeze. And therin lies the rub: there is no such thing as bulk processing here. Loan modification at the end of the day is a note-to-note exercise. Which, I guess, leaves us with another question: who exactly is paying for all of this?