Marketplace Scratch Pad

No more interest-only loans

Scott Jagow Feb 26, 2010

The government-controlled mortgage financier, Freddie Mac, said today it would stop buying “interest-only” loans. How common-sensical of them. You remember these — you pay interest-only early on in the loan, but later you get socked with balloon payments. Lots of low-income or weak-credit borrowers took them on. And lost.

The Financial Times explains Freddie’s move:

Michael Cosgrove, a Freddie Mac spokesman, said the company’s decision to stop purchasing interest-only home loans was another step in its efforts “to promote responsible lending”.

Rafay Khalid of Standard & Poor’s said the move showed that the government, while continuing to support the housing market, was slowly draining some liquidity. “The government is taking off the training wheels,” he said.

But the big banks could get whacked by the decision:

Freddie Mac said that it would stop buying the fixed-rate and adjustable-rate interest-only mortgages on or about September 1, potentially dealing a painful blow to the holders of those securities, which tend to be large financial institutions. “Fannie and Freddie were the buyers of last resort,” Mr Khalid said. “Whoever is holding those mortgages should take a hit.”

But lest you think significant reform is coming to Fannie and Freddie, there’s this from The Street:

The federal government has again extended the horizon for meaningful reform of Fannie Mae and Freddie Mac’s business model, another sign that the firms are too interwoven with current policy to change the status quo and that their problems are too complex to resolve overnight.

Appearing before the House Budget Committee on Wednesday, Treasury Secretary Timothy Geithner said the plan for Fannie and Freddie will not be outlined until 2011. The government will release a set of “principles and broad objectives” sometime this year, according to Geithner, which will be open for public comment.

Instead of taking decisive, aggressive action, the government is postponing the pain.

Kind of like a balloon payment.

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