Let's listen in on 2 mice: K and M, discussing the bailout plan
K: of all the places we jumped to, we chose 850B as the landing pad though? I think all existing mortgages should have been maintained in an escrow acct by the government, then all properties auctioned off at a fire sale. Then the occupant should be given first option to refinance on a 30 yr fixed against the new property value as established by the market auction process or the current mortgage, whichever is lower. In this idea, the government acts as escrow agent until the property is auctioned
Example: i bought it for 300 on a 5 yr ARM. I keep paying my payment to the government until its auctioned, it's auctioned off at 200 to a bank of investment group. I get first option to buy it from them at 200 with a 30 yr fixed. All the payments I made to the government escrow acct get applied against that new contract as equity/downpayment.
M: I agree that the $850B landing pad seems like an odd place to land. The real problem in my mind is the lack of liquidity.
K: Thats how you establish the new true market value of the house and protect the homeowner and give him a chance to benefit from the new market price, and maintain continuity of payments. Let banks borrow from the Fed at a rate that reflects their own credit worthiness. Now if you argue that banks that are not credit worthy should be offered credit i must ask: why is that ever a good decision?
M: For example, in your scenario, somebody had to eat that $100k that the property went down. I think there were so few people still making payments on some of these properties that even if somebody was willing to eat the $100k (the government or whoever) - the homeowners would be unable to stay in the house and make payments - even if the supposed market price of the house was now $200k.
K: Let the many smaller banks and credit unions that didn't blow up get credit from the Fed as a reward for having been good stewards of the public trust. The 100k loss is eaten by the bankrupt bank in their bankruptcy process
M: The real issue in my mind is the irresponsible borrowing and lending that has gone on.
K: so lets say the 300k property, was now valued at 200k, and the current occupant cant make payments on a 200k house. Too bad. The new property owner bought the 200k house from the government who repo'd it from the bankrupt bank.
M: So - if the bank eats the $100k loss - if they have enough of them, they go out of business. The problem is that all of these folks were doing this and they turned them into investment vehicles that dropped in value.
K: then they SHOULD go out of business! there are plenty of banks who didnt do what we are bemoaning.
those are the banks that i want to risk liquidity on, not rescue the idiots.
M: I don't think we're talking the difference between $200k and $300k mortgages. We're talking about people making $50k per year living in $600k houses or some such thing. (We've all heard the (reports)
K: we will discover those houses, right now, are not worth 600k. What are they really worth?
M: I don't disagree that those banks should go out of business.
K: They are worth what an auction process will discover, in the same way that the real price of a abandoned car is what you can get for it at the police auction
M: Well - what they are really worth - that's the whole mark to market thing. What is the market? If an auction is the market, you will get investors with cash pay 50% of the original price (or something).
K: Thats what its worth, and there is your liquidity. All the money sitting on the side that came out of the market now has a place to go fast, and its not tax payer money providing liquidity. It is the cash of prudent money managers, who should be rewarded for good stewardship
M: But - it doesn't solve the problem for the homeowner.
K: the homeowner still has an option of buying the house at the new price as established at the auction
and with a 30 yr fixed at VHA rate. My gut says the “600k house" is only worth 300k at auction
M: Those people don't have any money or any credit. We got into this problem by lending to people with questionable credit - would we do it again? Who would take that risk? None of the banks that I hear about right now. They are all guarding their liquidity.
K: Now the government is prepared to give VHA funding for a 300k house, not a 600k house, based on the reasonable price just established
M: So - then it becomes a government bailout? At least a government guarantee - yes?
K: the current bill puts the government at risk by buying the 600k loan, and then trying to resell it later to someone for a profit
K: it makes the government responsible for figuring out the real price. We should act as escrow agent until the auction price is discovered. We should charge people to live in the houses at the zip code rate that we give to service members for living in houses near there. When the auction happens then they get first crack to but it at the newly discovered price. They get to use their judgment and then look for housing within their means, knowing that if that 600k house really is 600k then they are going to move anyway, but this way they aren't immediately booted.
According to this thought process then : dumb banks are not rewarded, dumb people are not rewarded, good stewards are rewarded, government and taxpayers are not at risk, auction price establishes new true price, credit is extended to solvent banks and credit unions who were good stewards, liquidity is enticed into market off the sidelines. Just me thinking out loud.
M: we should be trading not talking, let's get back to work!
Ken Long, Chief of Research, Tortoise Capital Management finance: http://www.tortoisecapital.com essays: http://kansasreflections.wordpress.com
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