(2008-03-13) Fed Mortgage Rescue

The Federal Reserve decided to rescue some banks by acting as Buyer Of Last Resort of Sub-Prime holdings. The falling prices have forced selling by major institutional investors and lenders, partly to make up for other losses, and has spread to a much broader array of seemingly safe securities.

Tom Evslin thinks this was a bad Bail-Out move. The solution to this crisis isn't rocket science; it's a Work Out of the kind that banks do all the kind when a commercial loan turns bad. The reality is that many houses aren't currently worth the amount of the mortgages they secure and so those mortgages and securities based on those mortgages aren't worth their face value either.

Back in February Treasury Secretary Henry Paulson spoke against a Bail-Out of borrowers. In an interview yesterday, Paulson said that a bailout would more likely rescue reckless lenders, investors, and speculators than be of any real assistance to the stated targets of such a plan - struggling homeowners who cannot afford the rising mortgage rates they now face.

But everyone had a plan.

Back in December Arnold Kling quoted some estimates on size of the original-borrower group. Citing a source called the Center for Responsible Lending, they say that there are 7.2 million families who have a subprime mortgage, 1.8 million with interest rates that reset in 2007 or 2008, a total value of $1.3 trillion, with 14 percent now in default and ultimately 20 percent of the loans originated in 2005 and 2006 expected to go into Fore Closure.

James Surowiecki summarizes the situation. Most money that's borrowed these days no longer comes from Commercial Bank-s, which are responsible for less than thirty per cent of all lending (Debt Financing). Instead, in one form or another, the loans are packaged and sold as securities. And since Investment Bank-s do much of the selling and buying of those securities, they play an ever bigger role in financial markets.... We don't want the paralytic level of skepticism that has reigned in the marketplace in recent months to continue, but we don't want a return to the way things were, either. It's a good thing that Bear-Stearns was saved. But it's also a good thing that it nearly died.

Mar24: J P Morgan is trying to sweeten the deal to $10/share. If the price is increased, however, some critics could have more ammunition to complain that taxpayers are helping to bail out a Wall Street firm that should be responsible for its own risky behavior. That is one reason the Fed was hesitant on Sunday night to approve the transaction at $10 a share, people briefed on the talks said. Many shareholders felt the $2/sh Fed-imposed price was too low. Some of Bear's largest shareholders have even considered voting down the deal to send the firm into bankruptcy protection, where they speculate they might get more than $2 a share from creditors. Interesting discussion of this. more - more