High-yield/macroeconomics (fka YIELD)

[Preciouslife1]

Rescue Plan Without Taxpayer Money

http://www.nytimes.com/2008/11/16/business/16gret.html?ref=business&pagewanted=print

HELLO, taxpayers. Worried about the fate of the $350 billion that the government has asked you to fork over so far to help rescue financiers from themselves?

Last week, Treasury Secretary Henry M. Paulson Jr. gave you every errant golfer’s favorite response: Oops! Mulligan!

While the government still declines to say exactly how it has spent your funds, or who all the beneficiaries are, Mr. Paulson conceded that his huge capital injection hasn’t persuaded banks to lend more money.

When he first peddled the “troubled asset relief program” in September as a solution to the credit mess, he urged Congress to back the plan posthaste. But on Thursday, he scotched his idea of using even more of your billions to buy rotten mortgage assets from banks.

Looking on the bright side, there is something to be said for flexible responses to a complicated financial crisis.

But now that the original TARP design has been toe-tagged, and because there’s still another $350 billion left for Mr. Paulson to deploy, perhaps it’s time to consider actually attacking the root of the problem: falling home prices and rising delinquencies and defaults.

Since the $700 billion TARP was funded, it has been used solely to shore up banks and other financial institutions. (An irreverent friend calls it The Act Rewarding Plutocrats.)

Treasury officials did move closer to helping consumers with a new plan floated last week aimed at offering $50 billion in loans to companies that issue credit cards, make student loans and finance car purchases.

Kind of interesting, isn’t it, that troubled homeowners are missing from the list of TARP beneficiaries and left to fend for themselves?

To be sure, private efforts to modify mortgages have increased recently; Citigroup, JPMorgan Chase and Bank of America have all announced plans to restructure troubled borrowers’ loans. So have Fannie Mae and Freddie Mac.

But these efforts are limited to loans that these institutions hold. They don’t address the millions of loans sitting in securitization pools, those profitable instruments cobbled together by Wall Street that are collapsing en masse.

Wall Street engineering has created an epic problem: restructuring loans bundled into pools of securities is much thornier than simply changing the terms of individual loans residing inside individual banks.

Not only do such changes require the approval of hard-to-identify investors who essentially control the mortgages, but also many pools were designed with rules that limit the numbers of loans that can be modified.

Securitization trusts hold $1.5 trillion of subprime and alt-A loans. As of late August, according to figures from the Securities Industry and Financial Markets Association, roughly $400 billion of the loans were delinquent and $1.1 trillion were current on interest and principal payments.

But that latter group of loans could become troubled as well if more borrowers become unable to pay (which rising unemployment figures suggest might be the case).

To make matters worse, many borrowers will face severe interest rate resets on their adjustable-rate mortgages next year and beyond. A new report from Demos, a public policy research group in New York, points out that millions of mortgages are ticking toward a possible explosion.

The report, citing data from First American CoreLogic, a real estate research firm, says $250 billion in loans will reset in 2009 and $700 billion in 2010 and after. If left on their own financially, many of these borrowers will be forced into foreclosure.

Still, there are many smart ideas floating around about how to solve the twin problems posed by securitizations and resetting mortgages.

One interesting idea was conceived by two veteran investment managers, Thomas H. Patrick, co-founder of New Vernon Capital, and Mac Taylor, a principal of the Verum Capital Group.

They propose refinancing all $1.1 trillion of the loans in securitization pools that are still performing but that may soon face punishing interest rate resets.
Homeowners whose loans are in these pools would receive newly issued loans with fixed interest rates, currently 6.14 percent, and 30-year terms. Under this plan, Fannie Mae and Freddie Mac would issue debt to pay off the outstanding principal on the loans and then guarantee the new ones.

Voilà: Investors who own the underlying interests in the mortgages would be fully repaid and the securitizations would be closed out.

“Our proposal is based upon the fundamental principle that the only way to ameliorate the problem is to somehow improve the underlying collateral,” says Mr. Patrick. “It rewards those homeowners who have paid their mortgages and have demonstrated financial responsibility.”

Currently, with everyone worried about more losses, the securitizations are trading at rock-bottom levels.

Because big banks and other financial institutions hold most of the securities, refinancing the $1.1 trillion in securitized loans would provide big capital infusions to many of the entities the Treasury is trying to help with TARP, Mr. Patrick said.

But while TARP involves direct payment of taxpayer money to banks, the Patrick-Taylor plan would create losses for taxpayers only if the refinanced loans took a hit later on.

There’s another benefit. Remember all those complicated products like collateralized debt obligations and credit default swaps that have been scaring the pants off people and causing some financial giants to look into the abyss?

Well, the Patrick-Taylor plan would reinflate the value of C.D.O.’s made out of bundled mortgages. And firms that sold C.D.S.’s as insurance against mortgage defaults would also get a boost (the biggest bailout recipient, the American International Group, for example, has been struggling to pay billions of dollars in collateral on weakening C.D.S.’s).

The investment managers reckon that their plan would give the financial system an immediate capital infusion of about $385 billion. That’s their estimate of the difference between the value at which depressed mortgage securities are now valued — 65 cents on the dollar — and par value.

If the assigned value of those assets drops even lower than 65 cents, then the financial benefit to the banks of the Patrick-Taylor plan would be greater.

In return for all of this financial aid tied to the $1.1 trillion of securitized mortgage loans that are still current, the Patrick-Taylor plan would require banks to buy the $400 billion in delinquent securitized loans at full value.

The banks would have to absorb any losses they incur when selling the underlying mortgages. But that’s a small price to pay for getting out from under this albatross.

IT is impossible to predict how much financial institutions might lose on that $400 billion. But it is likely to be less than the losses they will suffer if they sit idly by while defaults and delinquencies accelerate.

Because the program would provide such a boost to the banks, Mr. Patrick said, these institutions should be required to absorb a portion of possible losses on the $1.1 trillion in healthy loans guaranteed by Fannie and Freddie. The Treasury should be able to bludgeon them into eating some of these losses, Mr. Patrick argued.

“This set of securities is what started the fire: it’s what brought down Merrill Lynch, Lehman Brothers and Bear Stearns,” Mr. Patrick said. “You can’t deal with the securities in their current framework, and you can’t solve the problem one mortgage at a time. If we eliminate these securities, strip away the complex structure, we can fix the banking system.”

Under the Patrick-Taylor plan, homeowners would also be helped. Future delinquencies might be reduced, and the downward spiral of home prices could be curbed.

Worth at least a moment of our leaders’ consideration, don’t you think? At the very least, it’s better than a mulligan.