The Mother of All Mortgage REITs

I had some fun reading the text of the proposed treasury bill last weekend, which also happened to be the subject of some thick political theatre at the Senate Banking Committee hearings yesterday. As far as I can tell, the bill basically authorizes a $700 billion government-run Mortgage REIT that has yet to be named. Perhaps we can all agree that simply calling it "expensive" would be appropriate. Not only that, the draft of the enormous bill, which requires an increase in the federal debt ceiling just to accommodate its incredible cost, runs a mere three pages long. I've actually seen trade confirmations with more black ink than this bill. But when it comes to government spending, brevity is the soul of the ultimate form of OPM: your tax dollars! (OPM=Other People's Money.)

The still nameless bill gives the Secretary of the Treasury, who would be the new Master of the Universe upon its passage, very broad authority to buy, sell, trade, loan, finance, refinance and repurchase, all at the same time if he wants, any type of mortgage asset that was originated prior to September 17th, 2008. The broad mandate to "finance" and "trade" means that the bill could wind up funding the purchase of even more than $700 billion in assets. So, for the next two years, the treasury secretary will be running one of the largest, most influential proprietary trading desks in the world, since foreign banks are also expected to participate under the proposed rules.

If this also sounds to you like the government will be running a giant Mortgage REIT reminiscent of the glory days of loss-belching CDO factories, you'd be about right. The one notable exception is that the government, in its infinite wisdom, will be giving up all the juicy management fees to the likes of Black Rock and other private-sector money runners.

Black Rock will undoubtedly be one of the asset managers tapped to manage this huge, government-run REIT, since they are already looking after what's left of the toxic Bear Stearns portfolio. Perhaps that part of the bill makes Anthracite (AHR) worth yet another close look. I do love intriguing conflicts of interest, especially when they can be turned into money making investment ideas.

Significantly, the "mortgage-related assets" are expected to be purchased through a type of "reverse auction", in which the the institution that is willing to sell its assets for the lowest amount would be the "winner". If this seems oxy-moronic and hard to understand, it is, because it puts the government in a big quandary: Does Uncle Hank pay more than fair-market value for assets nobody else wants, thus putting even more taxpayer dollars at risk? Or does he drive a hard bargain, buying this stuff for a few Abraham Lincoln's on the dollar?

That latter strategy would further harm the very financial institutions he is trying to assist, since they would have to take additional hits to their already underwater balance sheets, which would lead to even more loss-driven scuba diving. Not only that, mark to market accounting would require other non-sellers to mark their portfolios to these distressed trades. Has anybody seen my rebreather?

The congressional testimony was even more amazing. Bernanke candidly admitted that the idea was untested and basically still half-baked. "We don't know what's going to happen", he answered in response to one interlocutor. Hank Paulson offered even less certainty, admitting that "there will be a certain amount of experimentation".

Will this three page bill get passed, even if nobody knows how it's supposed to work? You betcha. Senator Shelby, the Republican from Alabama, said in an interview with CNBC that "things can move up here real fast once the skids get greased". Is it really true that nothing can get done in our government without some sort of quid pro quo?

Bernanke and Paulson also turned their bazooka on congressional leaders last Thursday night, appropriately scaring them half to death with various meltdown scenarios. "When I heard his description of what might happen to our economy if we failed to act, I gulped," said Democratic Sen. Charles Schumer of New York, referring to Bernanke's appraisal of the capital markets and the economy. Chuck, repeat after me: can you say "Banking Failure"?? Why nobody was gulping before Thursday night is beyond me, but I guess no congressional leader had an account at Lehman Brothers, either.

Why is this bill so incredibly spectacular? Don't bother me with $700 billion, that has nothing to do with it. It's because of the red-hot bit buried at the end, which is undoubtedly because the bill is so short there isn't even any room for fine print. In some of the versions that were posted online, this particular section is even omitted.

Score: Obfuscation 1, Transparency 0.

Specifically, it is the definition of "Mortgage-Related Assets" that is so amazing. The current version of the bill defines Mortgage-Related Assets as "residential or commercial mortgages and any securities, obligations, or other instruments that are based on or related to such mortgages, [emphasis added] that in each case was originated or issued on or before September 17, 2008".

This may seem innocuous in its simplicity, but it's definitely not. This definition means the government can purchase and trade ANYTHING with a mortgage tied to it. There are absolutely no exceptions. Accordingly, it would enable the government to purchase everything from bad Credit Default Swaps to failed CDOs and CLOs, and almost everything else in between, as long as it touched a mortgage somewhere along the line in the credit bubble sausage factory.

So it looks to me like the bill not only authorizes the creation of a huge government-run Mortgage REIT, but since the bill also enables the government to issue securities to purchase the REIT's assets, it also authorizes the government to issue IOUs resembling one of the most toxic securities of all time: the infamous "CDO Squareds", or CDOs tied to other CDOs and CDSs. Am I crazy, or have we now just come full circle?