Sunday, April 22, 2007

Who Would JP Morgan Invite?--III

The staff and consultants here at Underbelly World Central have been puzzling for weeks over just how a subprime mortgage meltdown would play itself out in detail. It’s gratifying to note that the rest of the world is at last getting with the program (see “Who Would JP Morgan Invite?” – Part II (link) and Part I (link)). It is gratifying, therefore, to see the rest of the world at last getting with the program.

Here, for example is an instructive collection of insights at The Housing Bubble Blog (link). Here’s a teaser:

“I am guessing the subprime bailout will come in the form of some kind of taxpayer-provided insurance. This is a good way to get taxpayers to assume the costs, as few taxpayers understand that loading up the balance sheet of explicitly-guaranteed government agencies like the FHA or implicitly-guaranteed (too-big-to-fail) government sponsored enterprises like Fannie Mae or Freddie Mac with toxic mortgage debt is a form of taxation.”

“However, one would have to pay premiums to a private insurer to assume the risk. In lieue of premiums, the cost assumes the form of a time bomb that will go off at some indeterminate point in the future when one of these debt-burdened agencies blows up and taxpayers are billed for the cleanup costs.”

Underbelly believes that government “insurance” is the most insidious form of government expenditure because it is so beguilingly easy to sell and because it is almost never possible to pinpoint the cost (who, even today, has a good notion of the true cost of the Savings and Loan debacle of the 1980s? And just in general, as a card-carrying, if not really paid-up, member of the “I’m Alright, Jack” club. I’ve already squeezed most of the subsidies out of the system that I am ever likely to get and I am not eager to finance anyone else’s.

Another commentator to hit the topic head-on is the formidable Gretchen Morgenson at the New York Times (link, but $)—although to be fair, she has had her arms and legs around the subprime story from the get-go. She says:

Because of the way mortgages are packaged into pools and sold to investors, it is still not clear who owns the faltering loans and how much money has been lost. The episode seems to be unfolding in slow motion.

At the risk of sounding cheerful, allow me to suggest one possible bright spot in all this mess: it may be that what we are seeing in part is simply the virtue of diversification. Even if California does, in fact, have three times as many foreclosures as it had a year ago, no individual bank goes under. That is precisely because we pooled all this stuff into portfolios designed to soften the hit—and, miracle of miracles, they are doing exactly what they are supposed to do.

I don’t want to make too much of this. Underbelly believes that this rollie-coaster still has a long way to roll. And it remains true, as an earlier commentator said, that nobody really “owns the problem” yet, in the sense of feeling motivated to try to work out a meaningful solution. But if we are really lucky it may be that this problem will in the end turn out to be, if not exactly entertaining, still bearable.

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