Paulson defends 'freeze' plan

In a speech Monday, the Treasury Secretary said the subprime crisis raises the 'potential of a market failure.'

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By Jeanne Sahadi, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) -- Treasury Secretary Henry Paulson used a speech Monday to defend a plan brokered by the Bush administration to "freeze" mortgage rates for some subprime borrowers and also to call on Congress to pass legislation to head off a housing crisis.

"Over the next two years, we ... face an unprecedented wave of 1.8 million subprime mortgage resets, raising the potential of a market failure," Paulson said.

By coordinating the alliance of lenders, servicers and investors known as Hope Now, which is implementing the rate-freeze plan, the Administration is helping to prevent avoidable foreclosures and safeguard neighborhoods and communities without using taxpayer money, Paulson said.

Critics of the plan fall into two camps.

There are those who say the rate-freeze plan is a start, but it's a late one and not sufficient to address the size of the problem.

Others say adjusting mortgage contracts amounts to a bailout - free-market principles say that those to take on risk should suffer the loss when bets go bad.

Paulson fought back against critics Monday, saying the perception that his plan abrogates contracts is mistaken.

"It does not," Paulson said. "Mortgage servicers have contractual obligations to their investors, who are spread all over the world. Servicers will fulfill these contractual obligations by pursuing all loss-mitigation options when it is in the best interest of investors, as they normally would."

Supporters of the rate-freeze plan note that the knock-on effects of a foreclosure crisis can derail the economy, hurting even responsible borrowers.

Paulson has said several times the rate-freeze plan is not a cure-all. "There is no single or simple solution that will undo the excesses of the last few years," he said Monday, and added that the rate-freeze plan is not subsidized by taxpayer dollars but helps the Administration "fulfill our primary responsibility of protecting the broader U.S. economy."

Paulson also used his speech to reiterate the Administration's call to Congress to to push new legislation that would reform the Federal Housing Administration (FHA).

The FHA program is intended for homebuyers and homeowners with weak credit. They get FHA-insured loans from lenders as they would any other mortgage and pay a small premium to the FHA every month. The FHA uses those premiums to cover the lender in the event of foreclosure and requires lenders to help borrowers avoid foreclosure.

FHA reform would lower down-payment requirements, increase the cap on loans eligible to be FHA-insured, and lower fees, among other things.

"We have urged Congress to move quickly ... by passing the FHA modernization bill to provide financing for approximately 250,000 borrowers," said Paulson.

In addition, Paulson again called on Congress to pass greater oversight of Fannie Mae and Freddie Mac, and with that an increase in the size of mortgages that Fannie Mae and Freddie Mac can purchase.

Fannie (FNM) and Freddie (FRE, Fortune 500) guarantee the purchase and trading of so-called "conforming" mortgages, which are those valued at $417,000 or less. Any loans above that amount are considered "jumbo" loans.

An increase in the conforming loan limit would make it easier and less costly for borrowers in high-cost areas to get new mortgages and refinance old ones.

The Administration has said it would support a temporary increase in the loan limit, but only if lawmakers pass legislation that would subject Fannie and Freddie to more stringent regulation.

Ever since accounting scandals at Fannie and Freddie came to light in 2003, lawmakers have been debating how to reform the two agencies, which are considered government-sponsored enterprises (GSEs). That is, while they remain publicly traded companies and are not funded by the government, there is an implicit understanding that should they falter, the government would feel pressure to help out.  To top of page

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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer.

Morningstar: © 2014 Morningstar, Inc. All Rights Reserved.

Factset: FactSet Research Systems Inc. 2014. All rights reserved.

Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved.

Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor’s Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2014 and/or its affiliates.