A Brief History…

UPDATE: I watched Bush’s speech and Gingrich afterword on Hannity’s show. I still have doubts that this bill will pass in present form. I hope that McCain, who is the only one with credibility on this topic, will rewrite the bill along the lines I have indicated here. Dodd, the banking chair, and Obama are the two biggest recipients of money from Fannie and Freddie. That story is here by the man who might be the McCain Secretary of the Treasury.

UPDATE #2 Here is someone who really doesn’t like the bailout. I don’t know that I’m there but he knows more than I do. Sarah Palin gave an interview to Katie Couric today and got asked some pretty tendentious questions. Especially about “mortgage amnesty” and that is a terrible idea. Here is more about the bad ideas of Senator Durbin.

UPDATE #3 Here is still another idea. Why are we not seeing more about this ?

John McCain has announced that he is suspending his campaign to work on the financial crisis with Congress. So far, we have a $700 billion proposal to bail out the holders of junk securities. The Wall Street Journal, which has been warning about the Fannie Mae problem for years, says we have no choice and have to bail out the system.

The reality is that last week we had a global panic that included a flight from even basic financial assets like money-market funds and commercial paper. This was not Hank Paulson’s invention. Panics are real events. If allowed to become crashes, they can have terrible economic consequences. We were lucky to forestall a crash last week, but the underlying sickness has to be addressed to avoid a recession, perhaps even a deep one.

Senator Jim De Mint, one of the spending hawks in the Congress says “I believe it is completely unacceptable”. There is other opposition from Republicans who are concerned that Congress caused the problem and is unlikely to get the fix right. There are even those who doubt there is a crisis at all.

Donald Luskin is worried about getting it right.

First: There’s simply no objective way to know whether the banking system is as close to disaster as top officials at the Treasury and Federal Reserve claim. They themselves don’t really know. This is a “banking crisis,” they say. But then again, other politicians claim there is a “health care crisis,” an “immigration crisis,” an “energy crisis,” and so on.

Senator DeMint says the last time he was presented with a deal that had to decided immediately, he was on a used car lot. Can we believe that this is as bad as it is portrayed ?

Next: Of the $1.26 trillion in non-prime mortgages — that is, “sub-prime” and “Alt-A” mortgages — $743 billion is already either owned or guaranteed by Fannie Mae and Freddie Mac, companies that were shored up by a government rescue earlier this month. That leaves $521 billion, which means the Treasury’s $700 billion would be more than enough to buy them all. And that’s even if the Treasury paid full value. In fact, the Treasury will get a steep discount, considering that many of the mortgages in question are in delinquency or default. Does the Treasury really have to buy every single non-prime mortgage — even the healthy ones — twice over?

Who is going to be setting the price of these distressed instruments ?

Third: The officials advocating this — Henry Paulson and Ben Bernanke — are the same ones who, in similar haste, engineered interventions this year in the collapses of Bear Stearns, Fannie Mae, Freddie Mac, and American International Group. With each intervention the banking crisis has gotten progressively more severe. Experts differ on this, but it is my professional judgment that these interventions actually made matters worse, because of the unintended consequences that were nearly impossible to forecast at the moment of decision. We simply cannot know what unintended consequences might be unleashed in the process of a massive acquisition of mortgage assets by the federal government.

This has been a slow motion car wreck. Who is to say this will end it ?

The present proposal is primarily about the government acquisition of unwanted assets from solvent banks. The RTC acquired its assets automatically when thousands of banks and thrifts became insolvent and fell under receivership by the FDIC and the Federal Savings and Loan Insurance Corporation. There were no troubling ethical questions about which assets would be acquired, from whom, in what priority order, and, most critically, at what price. All the RTC had to worry about was eventually selling the assets it already had.

This is a serious concern and must be solved. Holman Jenkins has his doubts.

Treasury’s plan is to enter the market at a higher level, buying the depressed mortgage securities supported by these houses. In brief and eye-opening remarks in the Senate yesterday, Ben Bernanke spun a scenario in which derivative mortgage debt would be boosted in market value closer to the value of the underlying cash flow, restoring the banking system to solvency. Then why not just let banks value them that way on their books now, so they aren’t teetering on insolvency? Wait for it. We’ll get there, but not now apparently.

Nor does the Paulson plan have the Occamite virtue of cutting to the heart of the problem, the housing market. So many mortgage cash flows have been sliced and diced and spread over different kinds of securities owned by holders all over the world — a big stumbling block to the private sector trying to manage its way out of a hole. It’s not clear the new agency offers a solution to this problem. It would probably have to buy the entire outstanding stock of questionable mortgage debt before it would have any hope at getting at the underlying collateral, i.e., houses. But then it would become the world’s biggest, most troubled landlord and biggest forecloser on homes. Politics would intervene — and any potential taxpayer gains would likely be frittered away to keep nonpayers in houses they can’t afford.

Jenkins has a suggestion:

Here it is: [One] Let the government be a buyer of last resort for mortgage derivatives for a set price (say, 25 cents on the dollar), hoping others will gain confidence to step in. Hope, too, that this whets the appetite again for investors to recapitalize hurting banks. If banks continue to falter even with the option to dump their mortgages on government for a deep discount, deal with those challenges as they occur, with forbearance where possible. Meanwhile, [Two] use taxpayer dollars to clean up the housing mess in the Southwest and Florida — the surprisingly confined source of all our troubles.

Every time we mention demolishing houses, somebody slaps us over the head with Bastiat — the French economist who’d say you don’t increase wealth, you reduce it, by destroying some houses to make the value of others go up.

True — but we’re in a situation today where responsible homeowners will pay one way or another for the acts of irresponsible lenders and buyers. The cheapest bailout would be one that weeds out enough surplus housing to stop the free fall in a handful of overbuilt markets, whose foreclosure epidemic is dragging down the entire securitized mortgage market. We’re talking about buying thousands of houses, not millions of mortgages. And yet the resulting higher mortgage debt prices automatically would help to recapitalize the banks, while (knock wood) leaving some Paulson powder dry for future contingencies.

Deroy Murdock has another interesting suggestion:

First, declare that Fannie and Freddie are dead. Make this painfully clear to everyone by using crowbars to pry the brass nameplates off of their respective headquarters buildings.

Second, pour their assets into a new, temporary agency whose legal authority expires within 90 days. The Asset Breakup Corporation will supervise Fannie and Freddie’s orderly dismemberment and sale in much smaller pieces.

Third, use Fannie’s and Freddie’s databases to create a list of their customers ranked alphabetically according to the individual homeowners’ surnames.

The first set will contain people whose surnames begin with the letter “A.” Americans named Aaronson, Adams, Alvarado, and Antonucci. The second will consist of those whose surnames begin with “B.” People named Baca, Benson, Berkowitz, and Brooks will compose this category. Next, people surnamed Caruso, Charles, Chavez, and Chung will populate the “C” group.

This simple method soon would divide Fannie’s and Freddie’s assets easily, fairly, and transparently into 26 distinct slices.

Then, sell them off. I’m sure we will see plenty of suggestions over the next few days but I don’t think the present Paulson Plan is going to be adopted. At least, it won’t be adopted in this form.

Tags: Congress, Fannie Mae, Freddie Mac, Paulson

This entry was posted on Wednesday, September 24th, 2008 at 12:48 pm and is filed under financial, politics. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.