Department of Wha--? Salmon on Mortgage Buybacks

Felix Salmon has an uncharacteristically boneheaded piece up about mortgage buybacks. Apparently Thornburg Borrowers' Unit (who?) is auctioning off some of its scum mortgages--with a proviso that current borrowers can't bid.

Or more precisely, on two levels--Thornburg for establishing the proviso, Salmon for endorsing it. I haven't any idea what Thornburg's reasoning could be, but Salmon says it is a moral hazard problem: the borrowers who "are generally the most valuable of Thornburg's borrowers -- they're overwhelmingly likely to be the ones whose loans are worth par." I can't imagine where he gets that idea: the real framework is that for any individual mortgage, the borrower is the person most likely to pay the highest price. This has, in other words, nothing to do with the value of the mortgage relative to par; only to the value of the mortgagee's bid relative to other bids.

Bankruptcy trustees know this; since the mist of time, they have been selling the debtor's old ratty junk car back to the debtor because he is the one willing to pay most--and he pays most because he has the informational advantage, knowing exactly how beat up it really is, exactly how much change has dropped behind the set cushions, and so forth. There may also be a "non-economic" (can there be any such thing?) "sentimental attachment" factor, but this, too, only works to the advantage of the lender. Meshulam Riklis gained a kind of bankruptcy notoriety when he bought "his own" McCrory's Department store back from Chapter 11 in 1997. Creditors howled but couldn't offer a better bid (the deal later went sour--apparently Riklis paid too much).

Salmon further let his spleen cloud his judgment by saying it would cost taxpayers money in that a buy-back would be tax free--money "which would normally be taxed as income." This is oversimple, to put it charitably. In fact almost any direct write-down would almost certainly come under the (admittedly complicatd) Crane/Tufts "debt forgiveness" rules designed to put some or all debt forgiveness "income" beyond the reach of the tax collector.

The only unusual wrinkle in this deal is that Thornburg is apparently trying to sell these mortgages in "packages" (don't call them "S*c*r*t*z*t**ns"). Maybe Thornburg believes (like Salmon?) that they have a problem if the good ones get cherry-picked away. But even if this were true, the result wouldn't follow. The recent epidemic of "toxic" securitizations came about not because the assets were worth too little, but because the buyers paid too much. Anything is a bargain at the right price. If Thornburg doesn't want to deal with the debtors, that's their business (sic!), but it looks to me like they are leaving money on the table.

Fn.: The borrowers' own blog is fascinating.