Saturday, February 23, 2008

The Bank of America bailout

(Calculated Risk) I have no particular qualms about hanging BoA's name on this proposal. For one thing, they seem to have sent the memo. For another, they just "bought" Countrywide. (Who knows what the price would be net of this proposed government buyout of all the bad loans?) Edmund Andrews in the New York Times:

WASHINGTON — Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”

But as losses from bad mortgages and mortgage-backed securities climb past $200 billion, talk among banking executives for an epic government rescue plan is suddenly coming into fashion.

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.


So that answers the questions everyone had about the OTS-NEC proposal, such as how the hell it would work with securitized loans: it wouldn't. The government would buy those loans out of those pools first, so the NEC thingy wouldn't be owned by the security. But if you "position" it as a bailout of homeowners, nobody will "perceive" it to be a bailout of the bond market?

In practice, taxpayers would almost certainly view such a move as a bailout. If lawmakers and the Bush administration agreed to this step, it could be on a scale similar to the government’s $200 billion bailout of the savings and loan industry in the 1990s. The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

A rescue would also create a “moral hazard,” many experts contend, by encouraging banks and home buyers to take outsize risks in the future, in the expectation of another government bailout if things go wrong again.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

But a growing number of policy makers and community advocacy activists argue that a government rescue may nonetheless be the most sensible way to avoid a broader disruption of the entire economy. . . .

Ellen Seidman, a former director of the Office of Thrift Supervision and now a senior fellow at the moderate-to-liberal New America Foundation, said the government’s first challenge is to buy mortgages at their true current value. If the government overpaid or became caught by an even further decline in the market value of its mortgages, taxpayers would indeed be bailing out both the industry and imprudent home buyers.

“It’s not easy, but it’s not impossible,” Ms. Seidman said. “There are various auction mechanisms, both inside and outside government.”

A second challenge would be to start a program quickly enough to prevent the housing and credit markets from spiraling further downward. Industry executives and policy analysts said it would take too long to create an entirely new agency, as Bank of America suggested. But they expressed hope that the government could begin a program from inside an existing agency.

But even if the government did buy up millions of mortgages and force mortgage holders to take losses, the biggest problem could still lie ahead: deciding which struggling homeowners should receive breaks on their mortgages.

Administration officials have long insisted that they do not want to rescue speculators who took out no-money-down loans to buy and flip condominiums in Miami or Phoenix. And even Democrats like Representative Barney Frank of Massachusetts, chairman of the House Financial Services Committee, have said the government should not help those who borrowed more than they could ever hope to repay.

But identifying innocent victims has already proved complicated. The Bush administration’s Hope Now program offers to freeze interest rates for certain borrowers whose subprime mortgages were about to jump to much higher rates. But the eligibility rules are so narrow that some analysts estimate only 3 percent of subprime borrowers will benefit.

Bank executives, meanwhile, warn that the mortgage mess is much broader than people with subprime loans. Problems are mounting almost as rapidly in so-called Alt-A mortgages, made to people with good credit scores who did not document their incomes and borrowed far more than normal underwriting standards would allow.

Borrowers who overstated their incomes are not likely to get much sympathy. But industry executives and consumer advocates warn that foreclosed homes push down prices in surrounding neighborhoods, and a wave of foreclosures could lead to another, deeper plunge in home prices.

Right or wrong, the arguments for rescuing homeowners are likely to be blurred with arguments for rescuing home prices. At that point, industry executives are likely to argue that what is good for Bank of America is good for the rest of America.

Nobody is going to create a functioning new agency with the relevant expertise and staffing and funding and clear mandate out of thin air fast enough to do what this wants to do, if what we want to do is stave off recession. FHA probably has the expertise to credibly attempt the loan-level workouts, but not enough hands to get saddled with $739 billion worth that has to be dealt with before everybody's lawns go brown. Ginnie Mae is, in my view, one of the most efficient and quietly professional government agencies ever: they run a highly successful program with a tiny staff. I can't imagine Ginnie Mae is ready to manage reporting and remittances on a brand-new government-owned pool o' junk of this size with existing resources.

So of course the whole thing would be outsourced to some private company. I'm sure there's a financial institution out there willing to write up a proposal for how the government can pay it a management fee to orchestrate the government's bailout of its last attempt to manage mortgage-lending-related program activities.

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