Federal assistance in housing and financial markets

To avoid foreclosures 2 proposals have been made regarding ARMs by the senators Barney Frank and Chris Dodd (Frank-Dodd Bill).The plan is to resize and reset:
- FHA secure (loan modification): here, the loans exceeding 90% LTV will have their portion of debt above 90% ‘forgiven’ by the bondholders in order to qualify for the FHA protection in case of mortgage default. For instance, if the LTV is 100%, 10% of the loan is forgiven to reach the desired mark. Once the bond reaches the 90% LTV mark, they are insured and pooled as GNMA loans
- Fast Track program (refinancing): Convert ARMs to fixed rate – interest rate freeze for the first 5yrs

Coverage & Eligibility
These proposals can help 1-2m borrowers. It lowers both outstanding balance and monthly payments, and could help slow the decline in house prices.
-Applied to current or delinquent loans, but borrower should be at a risk of defaulting: LTV > 90%
-Loans on owner occupied properties originated between 2005-07, and free of all other liens (no home equity borrowers then?)
-Borrowers with debt-income greater than 40%
-Loan size limited to regional FHA loan limits

Effects
Initial loss to bond holders because of the upfront cost of forgiving portion of loan value exceeding 90% of property value. The lower tranches in CDOs (equity tranche) will get wiped out in this case. Long term risk to FHA in insuring sub prime debt.
Depending on the acceptance of this plan, it can strategically transfer the risk of sub-prime and Alt-A debt to investors (through forgiveness) and government (loan insurance)
- Rise in property value as foreclosures decrease
- Boost the value of MBS and CDO consisting of mortgages protected against default under FHA Secure - for instance if that particular pool of mortgages are based on relatively lower LTV, there can’t be that great of an impact. This crisis has presented an great opportunity to gain for people who have the resources to identify those mortgages which are trading at unjustified prices.
- Rise in repo activity (more secured assets available as collateral), and increase in loans drawn due to stabilization of property value. In short, ease in credit availability
- Hedge funds that buy MBS and CDOs at fire sale prices today might benefit largely from the passing of the Frank-Dodd bill which establishes default protection of risky borrowers who fit the eligibility criteria. The default probability of sub-prime and Alt-A, which is exaggerated by foreclosures, will reduce. Even in spite of this if the default occurs, the government under FHA Secure becomes liable to the higher tranche bond holders