The US Mega Conduit

From the NYT today:

When he announced a new plan to try to stanch the foreclosure crisis, Treasury Secretary Henry Paulson Jr. said that the officials, lenders and investors involved had been working toward it since August. That start date is a useful benchmark for measuring the plan’s inadequacy.

Only an estimated 250,000 borrowers, at best, are likely to benefit from the plan’s main relief measure — a five-year freeze on certain adjustable loans’ introductory rates. Yet, from mid-2007 to now, some 800,000 homeowners have entered foreclosure. From 2008 through mid-2010, when the last of the potentially eligible loans would otherwise reset to sharply higher payments, there will be an estimated 3.5 million loan defaults.

The plan is too little, too late and too voluntary. Mr. Paulson and his boss, President Bush, have left it to the private sector — the mortgage industry — to protect the public interest, without any negative consequences if it does not. That is not the way the private sector works. And it is not how government is supposed to work at a time when Americans are facing mass foreclosures that threaten entire communities, financial markets and the wider economy.

Many mortgage servicers — lenders and private companies that collect mortgage payments on behalf of investors — have been reluctant to modify at-risk loans, even though the alternative is to foreclose on thousands of homeowners. That is because they fear being sued by mortgage investors. For some investors, letting a troubled borrower default would actually be better business, for others not. It all depends on how their particular security is set to pay out.

The new plan establishes guidelines that lenders can use to determine which troubled borrowers might qualify for a rate freeze. But even lenders that stick to the government-brokered guidelines have no guarantee that they cannot be sued.

The criteria for who gets relief and who does not are also a problem. Some are reasonable: borrowers must live in their homes and have a good repayment record on their mortgage loan. Others are far too restrictive: borrowers can be disqualified if they have improved their credit score during the loan’s introductory period, a move that is intended to weed out anyone with even the smallest probability of being able to afford a payment that is set to explode, but which could subject homeowners who need help to delays and denials.

Investors may simply be too self-interested to pull off the aggressive, broad-based loan fixes that Mr. Paulson has said he wants — and that the nation needs. Rather than standing up to Wall Street, Mr. Paulson is hoping that the interests of investors — to make money — will magically align with the interests of homeowners, to keep a roof over their heads.

Mr. Paulson should be prepared to choose sides. If the voluntary efforts are not much more successful than expected — and soon — he should support the tougher approaches being called for on Capitol Hill. One bill would help shield lenders who modify loans from being sued by investors. Another would allow troubled borrowers to restructure their mortgages under bankruptcy court protection. Both would give the industry a strong motivation to ramp up loan modifications — or watch the courts take over. If the industry drags its feet, that is exactly what should happen.