The Fanny/Freddie Bailout: More Jam for Me, No Jam for Thee

Virtually all of my betters appear to be turning thumbs up (even if tepidly) to the Fanny/Freddy bailout, so I guess I do too. But it still seems to me that there's a fundamental issue here of "socialism for the rich" that shouldn't be dismissed quite so, well, quite so dismissively.

Yes, they tell us, it is true that we are (or may be) saving the owner's ass, but you have to do it save the economy. Well, who can argue with "save the economy"?--no thanks, not me. But phrasing the issue this way seems to conceal a rookie error.* That is: it is one thing to save the going concern and something quite different to save the equity. We may well need to save the business. But we can save the business even though equity doesn't get squat. Consider the crudest numerical example (I'm not deft enough with blogger to sketch a balance sheet, so bear with me): Liabilities $100. Assets, $50 in a simple liquidation, $80 if we preserve the going concern. Since $100>$80 and $100>$50, there is nothing for equity either way. But $80>$50, so creditors have a powerful motive to preserve the going concern even so. Tom Jackson used to call it "sellling the business to the creditor." Under Chapter 11 of the Bankruptcy Code, we do it all the time. There's no reason why we can't do it here, too.

A critic will object that I've made my life too simple by assuming I "know" the values--that equity owners deserve protection even when the balance sheet is upside down because they have a "lottery ticket value"--something might turn up--that deserves to be protected. I think there is a good deal of merit to this view (it would explain, for example, why Bear Stearns equity continued to trade even as the enterprise appeared to fall off the cliff. But this is an entirely separate issue: it's only a matter of how we parcel out the ownership stakes, not how we define them in the first place.

I suppose this was what I had in mind a few weeks ago when I asked: why doesn't the government just buy Bear Stearns, rather than planting a big wet kiss on the chops of JP Morgan (link)? I got a bit of offline flack on that one from people who said no authority blah blah socialism blah blah, government can't be trusted to run a blank blah blah and blah. Well, of course the government can't be trusted to run a bank. But it can perfectly well enjoy the residual share if, as, and when (if ever) that stake has value. And let JPM run it in the meantime, as a private contractor.

I haven't noticed anybody giving any serious thought to this kind of proposition. I suppose one argument for staying away from this perspective is that it is unfamiliar and therefore risky: in times of great uncertainty, we don't want to play around with the tried and true--so pay off the equity and move on. It's hard to argue with that. But I do wish I could see the wise men giving these kinds of concerns just a bit more thought.

Afterthought: Just for perspective, I am not that nuts about giving a lot of relief to homeowners in trouble, either. I think it is fair to assume that most of them understood perfectly well the risks that they were running, and that if the risk came out badly, why, them's the breaks. And not incidentally, I sign on with those who point out that if we spend a lot of public resources puffing up the wealth of current homeowners, we make housing just so much more inaccessible to all those who have not yet had their chance.

*I see I discussed this same "rookie error" a while back in complaining about Gretchen Morgenson (link)--and even included a balance sheet. Well, fair enough. Hey, you didn't listen before, you gotta listen again.

Uh, Let Me Rephrase that, Your Honor ...

Kedrosky says this is the headline at S&P today (link):

More Subprime Write-Downs To Come,
But The End Is Now In Sight
For Large Financial Institutions

Uh, is that really what you want to say?

What's Up with Athens, Ohio?

For anybody who cares about the housing meltdown, Calculated Risk is always a must-read--particularly today, with about 10 great posts, including this wonderful item about Athens, Ohio (link). Don't overlook the price graph at the end that looks like an extreme-sports ski slope.

You Can Never Have Too Much Non-Recourse Debt

So the Dow is up 417 points because the Fed has offered to loan $200 billion backed by mortgage-related securities (link). I assume these loans are non-recourse? I.e., if the value of the collateral falls to, say, zero, then the taxpayers get stuck with the bill? Isn’t this, then the biggest anti-deficiency loan ever, issued to well-nigh universal cheering and applause, into a market where we’re being told that walking away from your loans is a naughty thing to do?

And isn’t this gobbledygook?

The so-called Term Securities Lending Facility will allow strapped financial institutions to hand potentially damaged securities to the government in exchange for either cash or Treasury securities, whose U.S.-government backing makes them one of the safest investments on the market.

The Fed normally lends Treasury securities to banks for just a few hours. Under the new program, money will be lent for 28 days and the central bank will accept nongovernment mortgage-backed securities - the source of the current crisis in the credit markets - as collateral.

The Fed will require that the assets, which are linked to soured home loans, have a premium credit rating.

Update: A nonosecond after I posted this, I opened an email from my friend Margaret saying that I must read the current Krugman. Sure enough (link):

Some observers worry that the Fed is taking over the banks’ financial risk. But what worries me more is that the move seems trivial compared with the size of the problem: $200 billion may sound like a lot of money, but when you compare it with the size of the markets that are melting down — there are $11 trillion in U.S. mortgages outstanding — it’s a drop in the bucket.

The only way the Fed’s action could work is through the slap-in-the-face effect: by creating a pause in the selling frenzy, the Fed could give hysterical markets a chance to regain their sense of perspective. And to be fair, that has worked in the past.

But slap-in-the-face only works if the market’s problems are mainly a matter of psychology. And given that the Fed has already slapped the market in the face twice, only to see the financial crisis come roaring back, that’s hard to believe.

The third time could be the charm. But I doubt it. Soon, we’ll probably have to do something real about reducing the risks investors face.

See also: Bove: Fed Rescue for Bear Stearns(link).

BeenWondering if That Would Happen

Had been hearing some speculation on this (though mostly uninformed, I guess) from people who know about this stuff (link):

FBI Will Not Go After Borrowers Who Lied on Mortgage Applications

Feb 21, 2008

Borrowers who defrauded lenders by lying on their mortgage application could be thrown in prison for up to 30 years and forced to pay a $1 million fine under the current federal law. But the FBI says there is no intention to pursue borrowers at this time.

BY PAT SUMMERS

In 2006, the FBI studied three million mortgage loans and found that 30 to 70 percent of early payment defaults can be linked to misrepresentations in mortgage loan applications.

The figures aren't really surprising when you consider the fact that most of the defaults occurring right now involve borrowers who have not yet seen a payment reset. It is blatantly obvious there were an overwhelming number of borrowers approved for mortgages they could not afford.

The only way for this to happen was for someone to lie on a mortgage application. Some media stories have implied that it was lenders who did the lying and that most borrowers are victims of predatory lending schemes.

The truth is that borrowers did their fair share of lying too. More than 40 percent of subprime borrowers received loans without having to document their ability to pay. The borrowers simply 'stated' their income on the mortgage applications.

Almost 60 percent of stated-loan applicants inflated their incomes by at least 50 percent, according to the Mortgage Asset Research Institute. The worst part is that everyone knew the income was being inflated. The industry even had a name for these kinds of loans--'liar's loans.'

Source: Homeguide123. Get that bit about how "the borrowers did their fair share of lying too." From an industry trade mouthpiece, I'd take that as an iceberg-sized concession that a good deal of the lying was not done by the buyers--but rather was induced by the lenders, no strike that the brokers, who got their money in front and had a powerful incentive to bloat and exaggerate and flat-out lie whenever they got the chance.

What really gets me is how nobody up the line flagged the problem. There must have been hundreds of tweendecks underlaborers who processed this stuff and knew perfectly well that a lot of it was bollox. Apparently nobody had an incentive to own the problem, trusting, I suppose, that they would take their paycheck or commission and move on before the roof fell in.

Quote of the Day

From Housing Bubble Blog:

“In the fourth quarter of 2006, so-called equity extractions – from refinancing, home-equity loans or outright sales – accounted for about 17 percent of Californians’ disposable income, according to Scott Hoyt, the director of consumer economics at Economy.com.”

...and Arizona and Nevada were higher.

Who Supports a Housing Bailout?

Scanning foreclosure news, I find opposition to a bailout bill coming from a Representative from Modesto (link).

Say again, Modesto? Modesto, which just might be the foreclosure capital of the planet? Can he get away with that? Apparently he is willing to try. Reading stories like this (and listening to California voters on PBS tonight), it sinks in on me that not every voter may support the idea of a housing bailout. I suspect a lot of voters don’t cotton to the idea of saving shareholders of lenders (and I suspect they are a little hazy about arguments on preventing a bank meltdown). I’ll bet there are quite a few who see no compelling need to help those who used their houses as ATM machines.

There might be a little more compassion for first-time homebuyer, particularly if you can fudge the issue with mirror tricks like “stretchout plans” that don’t seem like real money.

On the other hand, I wonder if there may not be more leeway than usual for a candidate in either party who just says “sorry, tough luck.” I wonder how it is playing in Modesto.

Bad News that Bears Watching

Having lived through nine of the last four recessions (did I use this line before) I am an instinctive pessimist, always on the alert for more bad news. Hence I was delighted to run across Pension Tsunami, your one-stop shopping center for all sorts of bad news about the impending pension meltdown, both public and private. I will bookmark it right close to Housing Bubble, tempered by the more temperate but still scary Calculated Risk. And while I am at it, I might as well throw in the Payday Loan Industry Watch.