Bernanke & Paulson Need to Create a Mortgage Specialist Fund

Mortgage securities have grown into a $14 trillion asset class.  We have painfully learned how dependent our stock market is upon these illiquid debt obligations. Many, including myself, have voiced the solution to temporarily eliminate mark-to-market accounting requirements in order to give these securities time to recover alongside their real estate collateral.  We all know that this is a cyclical downturn in housing that will eventually turn, and we also know that the hastiness of mark-to-market valuations should never have been allowed to destroy so many reputable financial institutions.  

However, I now have a better idea. We need a more permanent solution than a suspension of accounting regulations or a bailout.   If we don't solve this, it will happen again.  The solution is the same solution that is used in other investable asset classes; Ben Bernanke and Hank Paulson need to create a mortgage specialist fund to buy securities when no buyers exist.  The specialist acts as the market maker to facilitate normal trading conditions during abnormal circumstances.  Just as every stock should have a specialist who is ready to step in and buy or sell as many shares as needed to ensure a fair and orderly market, so too should mortgage securities.

With the leadership of Bernanke and Paulson, Congress could turn this $700 billion bailout plan into a permanent specialist fund whose job is to provide constant liquidity for these mortgages.  The private sector could throw in another $300 billion to create a $1 trillion specialist fund whose objective is to manage large movements by trading out of their own inventory.  If there is a large shift in demand on the buy or sell side, the mortgage security specialist will step in and sell out of their inventory to meet the demand until the gap has been narrowed.  

If this backstop had been in place, it would have prevented the overreaction that led to Merrill Lynch (MER) selling its mortgage portfolio of $30.6 billion to Lone Star for $6.7 billion or .22 on the dollar. Without this $24 billion loss it would have prevented Merrill investors from settling for a 60% markdown to a $29/share buyout from Bank of America (BAC).  Lehman (LEH) employees would still have a company to work for.  

The ironic thing is that everyone saw this housing downturn coming but nobody could do anything about it.  We were left with a $14 trillion asset class and no market.  Congress has mentioned that they only want to go through this bailout process once, so let's do it the right way.  We have a serious structural problem when mortgage default rates are less than 10%, yet the mortgage securities have lost 80% of their value.  Let's treat the cause instead of bandaging the symptoms.

Disclosure: None

Comments

[bbzz24:]

mark-to-market is quite phony: it exeggarates price movements in either direction. but how reputable those institutions could indeed be if they cannot judge adequately their capital level???
maybe they were doing what they are best at: bidding up.

2008 Sep 25 06:25 AM

[User 269495:]

Puhlease - 'mark-to-market' = 'arms length transaction' = 'invisible hand' and is the fundamental basis of a free market economy. United Socialist States of America indeed.

2008 Sep 25 06:26 AM

[ev:]

I just emailed Bernake this morning requesting they consider a cap on Mortgage rates as part of the bailout plan for any institution that participates. This action would serve several purposes.

As a baseline, controlling the spreads for credit worthy individuals would in a sense, limit those that have been responsible in their endeavors participation in the bailout of reckless/inept/unscrup... individuals, by affording them cash flows at a reasonable rate and not allow the institutions a means of inflating the spreads to profit inordinately on the backs those of us who have been responsible in our financial dealings.

We certainly have a historical spread that can be referenced to set the cap. This should also serve to make rates more competitive in favor of the consumer as those institutions that don't participate in the bailout will not be getting any new business unless they are competitive in the market.

In the face of a comprehensive bailout plan, realizing that I, like everyone else is on the hook, would appreciate knowing that the spreads are required to be reasonable and these institutions are committed to normalized spreads.

Without suggesting collusion on the part of these institutions, I can easily see where they will push the limits on the spreads as this draws out. Eventually responsible consumers and businesses will need to address cash flows. Without these measures, I can easily see institutions holding out longer than the masses to the point that what is currently an excessive spread over the 10 year Treasury note becomes the norm.

2008 Sep 25 06:48 AM

[toanangel:]

OPINION
The bailout George Bush, Henry Paulson, who is the former CEO of GOLDMAN SACHS, Chairman Bernanke, Chris Dodd, Charles Rangel, and all their heavily lobbied bought and paid for cronies are pushing so hard to have us swallow as fast as possible

The lying, fraudulent, corrupt, greedy, flight or fear psychosis leaves without consideration for the most important part in this whole grand scheme.

Who you ask?

YOU -the Sovereign Citizen from whom all business blessings flow;

And just in case....

In God We Trust.

Okay, so we oversold and under estimated working citizens, who are raising their families and trying to have a home and hearth.

ONE SOLUTION PROPOSAL

Allow me to propose that major banks be given the freedom to set up holding companies to set aside their bulging debt portfolios, and a certain time, based on volume, to recast the mortgages in foreclosure or going into receivership.

Then allow them to base the new mortgage on current fair market values, or on the original appraised value, make the mortgages longer term or remove the adjustable threat factor, or whatever other creative ideas which only mutually benefit the homeowner and the mortgage contract.

Then the banks could off-set the bad-debt portion as a loss, absorbed by a government tax concession or other creative accounting means.
Then these mortgages already held in Freddie Mac and Fannie Mae already in receivership by the FED.

Perhaps this would prevent major punishments to everyone.
1. The homeowner would not have his credit rating destroyed.

2. The homeowner would have a chance to clean up his act and keep his home. After all they will have to pay rent anyway.

3. We would prevent the taxpayer, which is you, and the homeowner now tenant, being saddled with the debt leaving the banks whole and the criminals watching over the assets they have just stolen with tax payer dollars.

4. The Banks and major institutions can still have their equilibrium and capital finance markets restored, without destruction of the basis of their existence - the Us of A.

Investment Banker to the Mortgage Community
585 217 2191

2008 Sep 25 08:37 AM

[JCC:]

It is obvious to most that when you arteries are clogged, the blood doesn't flow. When you have blocked arteries it is an emergency, and to avoid a heart attack it is critical to get the blood flowing, which implies the use of a stent or open heart surgery. A complete blockage will result in a heart attack or worse. Time is critical, and the required correction is an emergency.

Analogous to your vascular system, the financial markets are the arteries of the economy. Analogous to your arteries, when the financial markets are frozen, the monetary supply does not flow. This creates an emergency situation where it is imperative that we restore the monetary flow.

In today's environment it is critical that we on an emergency basis thaw the financial markets thereby enabling the required monetary flow. There is not a lot of time to react. Waiting too long will create a severe recession or a depression.

2008 Sep 25 11:49 PM

[Steven Hansen:]

mark to market debate is silly. everyone knew this was coming. you know that without mark to market the balance sheets of european companies meant something different than american companies.

everyone failed at risk analysis. if you are a bank, you cannot hold assets which can fluctuate significantly in value. they ignored the warning signs to maximize profits. this painful exercise now is necessary because unlike other opinions, i believe the value to many of these assets will not return any time soon.

2008 Sep 26 12:58 AM

[sdh_lr:]

Hmmm. Is it suggested than that lenders would continue to be able to make loans with questionable underwriting? And, no, I do not mean sub-prime in particular. Residential real estate has been over-priced for some time due to persistent low cost of debt and increasing qualifications - longer terms, initially lower payments, less credit worthy. This CANNOT continue. Too much money chasing residential property.

2008 Sep 26 09:08 AM

[amm:]

Boy, if your idea of a solution is to stop mark to mark accounting then you just don't get it. Hey maybe, I shouldn't mark to mark my PnL and the losses might just go away. The solution is twofold. Limit leverage the investment banks and other financial institutions can take. Do not mix credit with real money.

2008 Sep 26 01:23 PM