Bush plays Santa this time

SMARTSHARE

In an attempt to prevent a further waive of foreclosures in the housing sector, the US has announced a five-year freeze on interest rates.

Fully aware of the backlash that the largesse would have otherwise generated, the government has restricted the freeze on rates to only those cases where the rates are going to reset beginning 2008 and through 2009, and where investors are not late by more than 30 days for their last installment, who have never been more than 60 days delinquent in the last one year and live in the same house they want to protect.

The plan leaves out any one who is judged capable of continuing to make mortgage payments at the higher reset rates. Borrowers who can't afford the loan even at low introductory rates will also be ineligible.

The short-term implications of this would be bullish for the equity markets as it sweeps the dirt under the carpet for the time being.

Housing prices could stabilise for a while, foreclosures could reduce as a large section of people get to remain in their houses, which they can no longer afford. But this is no panacea for the ills that swarm the US housing sector. The move is short- sighted and will only prolong the pain.

The government expects around 12 lakh home loan takers to benefit. But a study conducted by a leading brokerage shows that around 2.2 lakh accounts would be eligible for the freeze. Around 22 lakh accounts will come up for rate sets in 2008.

This means that around 90 per cent of the accounts coming up for a rate set higher will not get the relief. The very basis of the scheme was to ensure that there are no foreclosures, which would reduce the supply of existing houses and help keep property rates fairly higher than what they would have been had foreclosures become the norm.

The rate of loans entering the foreclosure process during the third quarter, as a percentage of total loans, was the highest-ever in history.

But even as policy-makers grapple with housing issue, signs of stress are creeping up in another key consumer area "" auto loans. Delinquencies are rising to their highest level in several years. Lenders are tightening the terms in some cases and interest rates have risen from rock-bottom levels of a few years ago.

About 4.5 per cent of auto loans disbursed in 2006 to top-rated borrowers were at least 30 days delinquent as of end of September, up from 2.9 per cent the previous month. That is the biggest one-month jump in the last eight years. The rising trouble in auto loans suggests that credit woes could be spreading to the broader economy.

Car loans are as different from home loans as chalk from cheese. During the regime of the ultra-low interest rates, home loans were extended on the assumption that the underlying asset, the home, was sure to keep rising in value.

As a result, a large section of the society was enticed into buying homes they could not otherwise afford. When taking out a car loan, both the lender and the borrower fully understand and appreciate the fact that the car's value will gradually decline over the years.

You can't, therefore, call a car loan defaulter a speculator, but someone who is unable to make what previously seemed like a manageable payment. That is why car delinquencies are closely linked to the health of the economy and tell you where it may be headed.

In the short run, the move in the US could kick our markets upstairs. But as we make hay while the sun shines, we need not forget that the galloping market-cap to GDP ratio is at 1.84. Russia is at 0.97, Brazil is at 1.25 and even China, whom the world considers a bubble, is at 1.53. The UK is at 1.73 but that is because a lot of non-UK based stocks are listed there.

In true Christmas spirit, we should be gratefully collecting those gifts from the Santas of the world. But like Jerry, we should stop short of picking the last piece of cheese ""where Tom has laid a trap.