Buying toxic mortgages: Hank and Ben made it sound good

Remember how brilliant an idea Treasury Secretary Henry M. Paulson and Federal Reserve Chairman Ben S. Bernanke thought they had in September: Take $700 billion of taxpayer money and buy up toxic mortgage loans from banks.

Freed of that garbage, the banks would lend again.

And by providing a market for the debt, the Treasury would help with "price discovery" -- that is, other investors would see what this stuff was worth to a buyer willing to hold it to maturity, and might follow with bids of their own that weren’t at extreme fire-sale levels.

On Wednesday, Paulson scrapped the asset-purchase plan, saying the Treasury would focus on better ideas for the remaining bailout funds, which so far have been used to make direct investments in banks.

Asked at a news conference whether he had misled Congress into approving the bailout plan, Paulson invoked John Maynard Keynes:

"We were focused on the problem. And the -- and when we went to Congress, the illiquid assets looked like the way to go. As the situation worsened [in the credit markets], the facts changed. . . . And I will never apologize for -- for changing an approach or a strategy when the facts change."

True, many on Wall Street said from the start that there was no workable plan for the government to buy up mortgage junk and feel confident that it was doing so at prices that were 1) high enough to help the banks yet 2) low enough to eventually pay off for taxpayers.

But Bernanke, for one, sure did sound confident that a plan could be constructed, as I related in this post in September.

And even as Paulson pulled the plug on Wednesday, the securities industry’s chief trade group was insisting that the program was, in fact, needed.

Tim Ryan, CEO of the Securities Industry and Financial Markets Assn., said in a statement:

"I am disappointed Treasury is choosing to de-emphasize the asset purchase portion of the TARP program. Based on my experience with the Resolution Trust Corp., I believe a key ingredient to a strong recovery is the creation of price discovery through some type of transparent purchase program.

"Until we have a functioning marketplace -- where buyers and sellers agree on prices and institutions can subsequently judge the value of the assets they hold -- uncertainty could keep many financial players on the sidelines, restricting lending capital for the larger economy. Treasury is uniquely positioned to bring these buyers and sellers together."

He also hinted that the industry would raise the issue with the next Treasury secretary. "As we move forward, and in planning for the next administration, we hope there will be further opportunities to comprehensively revisit this important program," Ryan said.

But one train of thought on Wall Street is that, with the Treasury now out of the way as a potential competitor, investment firms that focus on distressed assets (and there are many of them) will begin looking more seriously at what’s a fair price to pay for complex mortgage junk.

As I noted here, the manager of the $30-billion mortgage portfolio that was spun out of defunct Bear Stearns in March said Tuesday that the loans were generating cash flow as expected, and could end up being worth more than the portfolio’s current market value implied.

Some portion of this depressed mortgage debt is going to make a lot of money for brave investors, in time. For better or worse, the Treasury just won't be in that game.

Photo: Treasury Secretary Henry M. Paulson (Shawn Thew / EPA)

Comments

[TD Taxpayer]

Both Paulson and Ben Bernanke should be indicted along with Barney Frank and those upper level managers who have raped and pillaged our economic system to the point of bankrupting country. If Americans are to recapture their faith in the American dream, then there must be accountability which thus far under the Bush administration has not happened. Will these theives be brought to justice? It's up to the American people.

[Mig Mo]

Does this now mean that when we fill out our 1040's there will be a line for a dividend off our banking investment or are we just being set up.

[Martin Friedlander]

We were swindled again by the Bush administration in its final throes of its miserable existance. Congrees was sold on using the $700 billion to buy toxic mortgages. That money has been diverted to banks who are using those funds to buy other banks, pay dividends, pay executive compensation and bonuses.

What we need is a reformation of the Bankruptcy Code to allow "cramdowns" of residential mortgages. No homeowner in his right mind will pay one nickel on a mortgage that exceeds the value of his property. Only the bankruptcy court can reduce the principal amount of them ortgage to be equal to or less tan the property's current value. That is what bankruptcy courts do all the time. Instead the Republican Congress put a bankruptcy code before the President that, under pressure by the banks and credit card lobbies, eliminated chapter 11 cramdowns for residential property and created a means test for chapter 7 liquidation. If the debtor could not meet the means test then he was forced into chapter 13 which required him to repay his creditors 100 cents on the dollar. In other words these debtors became "indentured servants"

The existing bankruptcy code can still be utilized for corporate reorganization. During the reorganization process the automatic stay holds the creditors at bay until the debtor proposes a plan of reorganization. The usual corporate plan is to break existing contracts that are unbearable and creditors are turned into stockholder, thereby leaving the corporation with a clean balance sheet and new management. Then all the money that the federal reserve puts into GM would be equity to be used for purposes dictated by the government.

Bankruptcy si not a dirty word. Congress was expressly granted this power in the constitution to eliminate debtor prisons and indentured servitude for a period of 7 years. Do we want another penal colony like Australia.

In conclusion, not one nickel should be used for a bailout until thereis a new Congress and new President. Otherwise we would just be "pissing" our taxpayers' money away to benefit the priveileged few.

Martin S Friedlander, Esq.
Bankruptcy lawyer.

[saint%20peter%20ii]

They only made it sound to people who don't know much about spin doctors. It's time folks grew up and recognized that the federal bureaurats will say anything that's to their advantage and it's never to their advantage to look like they don't know what they are doing so in the many many cases where they are totally lost, don't expect them to tell you. Now they'll come up with some more useless and very expensive crap. Misters Drip & Drop did a segment of the 6:01 News that deals with the one way we can jump start this economy, sorry can't up load here but invite you to http://www.saintpeterii.com

[Sonia Martinez-Romaih]

I was there in DC, walking the corridors of the Rayburn building trying to speak with members of the Congress or their staff after the first vote. pressing them not to pass the bail out. The most disturbing aspect of speaking with those in favor was no one could give a solid reason for supporting the bail out. All anyone could do was spin, spin and spin some more about how the whole financial system would come crashing down. Yet, no one could say how or why the US economy would crash. Nothing made sense at all. I knew that it was a done deal, that all the protest, etc would not make a difference. I just remember leaving DC with a queasy feeling like it was all for nothing. Then there was a story about how "martial law" was threatened if the bail out was not passed. That would be a serious threat, I still don't understand how this bail out is going to help the people of the US and everything that has recently come out about it just makes me feel it was all the usual politics of the Bush administration -- a final give away to the people that caused the crisis. Why should we be surprised after the last 8 years?

[CY]

Nice of them to lie in order to keep the market up for the election saving the Republicans from a huge landslide in the election. This country is so messed up right now from TWO parties that treat business like paying customers and lie to voters who are supposed to be the ones they represent. Disgusting!!! Maybe they can give Ford and GM a few billion to make cars that no one will buy. Hey, that will keep the unions happy and the shareholders, screw the other stakeholders, like taxpayers.

[Jay S]

Bernanke had very little to do with this problem. It was that old coot Greenspan who should face criminal charges. That pompous,self-important, ignoramus ruined the economy that took so long to build. Now he admits to making errors in judgement. Where is the accoutability? Lock him up until the end of his days.

[Yoel Cohen]

Buying equity position in the banks and provide them with cash does not necessarily make the banks lend this funds or consumers borrow.
You can lead a horse to water but you can not make him drink.

What the government need is to start from the bottom and work itself to the top, providing work to unemployed millions will generate spending 5 times the original dollar spent and you can do it with start fixing the thousands of bridges, thousands miles of roads and other infrastructure of the country that are in dire need of repair.

[Ben]

This is a post election strategy to assure that the Bush administration allocates all the Bailout funds before the new administration steps in. Paulsen even said that the asset purchse plan was "too slow".

[LA / Certified]

Oceans 14??? This was the biggest Heist in the History of World Economics. As I've posted on previous threads none of this bailout will ever make it to Main Street. Now the remaining Banks will only loan money to A+ paper and oversees. Saturday Night Live said it best with their "Really" series. The same people that got us into this mess are now responsible for getting us out???? "Really" AIG gets 2 additional bail outs???? "Really". Valuation Services are no longer necessary??? "Really".

Remove these people before any more damage is done.

[Andy]

If I were in Congress I would feel duped! As a tax payer and pf blogger I am annoyed about all the flip-flopping and that our monetary leaders cannot figure out and implement a decent long term plan to get out of this mess.

[JS]

Elton Gallegly, Thousand Oaks, voted NO both times. He is in a very small minority. The Great Obama not only voted yes, but was one of the whips to bring the rest in line. McCain too.

So kindly get of your Democrat high horse - 90% of congress and senate couldn't balance a checkbook without an aide, so what makes you think they'll EVER spend taxpayer money wisely?

Asset values across all sectors must be allowed to find their own level.

Propping up GM, Ford and Chrysler to "save our auto industry" is even dumber. They don't make cars people want, so they suffer. Lets bail them out too. Wait a minute, Toyota, Nissan, Subaru - they all build cars here too, employing Americans. So someone can profitably make cars here, just not the not-so-big 3? How about you let them fail, and they finally deal with the bloated union contracts that give them the highest cost of production on the planet?

And to the BK attorney - if you and your brethren ever get the right to cram down a reduction in principal on a lender, you know the mortgage industry will collapse - leading to millions more bankruptcies. Boy, that's a good answer.

Next it's the home builders. What happened to their profits over the past 5 years? What about electronic retailers - surely Best Buy is too big to fail? Where will we get our 80" plasma TV?

Private profit, public loss. Caveman economics 101.

[Paul O]

The people in charge are either crooked or making it up as they go.

Probably both.

[Ron]

that was McCain's plan too. fortunately we won't have to worry about it being an executive order and that bad idea might really die.