THERE have been many proposals to deal with the problems in the mortgage market. But the best place to begin is by looking at the poor lending standards and weak consumer protections at the root of the problem — in particular, the troubling loans called 2/28 and 3/27 subprime hybrids. They have starter interest rates of 7 percent or more for the first two or three years, and “resets” that raise rates to as much as 12 percent, causing monthly payments to increase by at least 30 percent.
...
So subprime servicers should take a more standardized approach: restructure all 2/28 and 3/27 subprime hybrid loans for owner-occupied homes in cases where the borrower has been making timely payments but can’t afford the reset payments. Convert these to fixed-rate loans at the starter rate.
This would be no bailout. These borrowers would still be required to make their monthly payments — at rates higher than what prime is today. Billions in savings would be generated by avoiding the administrative, legal, marketing and other costs of foreclosure, which can run to half or more of the loan amount. And avoiding foreclosure would protect neighboring properties and hasten the recovery of markets burdened by an excess supply of houses.
As Dean Baker reminds us, resets aren't the only problem. Lots of people were given mortgages under terms they couldn't afford even before a rate reset. But they are some of the problem, they certainly represent a big chunk of the mortgages granted under absurd lending terms..