citetez

Nationalizing the U.S. Banking Sector: There's No Choice

Perhaps, as Jamie Dimon suggests, the reason the banks are not selling their "toxic assets" is because they realize that the media hysteria is causing them to be improperly undervalued. Rather than sell at firesale prices, the banks would rather hold onto them and wait for sanity to return to the market.

A Solution for the Bad Asset Pricing Problem

I have a proposal for resolution of the current housing/foreclosure/su... mess: Fannie Mae and Freddie Mac guaranteed long amortization loans to permit refinancing of unconventional loans into viable fixed rate loans given without reference to current loan to value ratios. This would lead to a rehablilitation of “toxic” mortgage paper and reflation of bank capital ratios. Best of all, it can be accomplished with minimal cost and risk to the taxpayer.
The current problem initially arose from borrowers in unconventional mortgages who were being squeezed by an increase in their rates and without an ability to refinance either because they cannot find a loan they can afford or because their homes are depreciated in value. They went into foreclosure creating a downward pressure on home prices. As home prices were pushed down, others found that their equity no longer supported the loan they wanted. This was accentuated by layers of securitization. The mortgages were branded as “toxic” and the cancer spread into the perception of conventional mortgages causing a freeze in the mortgage securities market and in lending. Banks simply cannot lend because their mortgages are considered “toxic assets” that have to be devalued by mark-to-market rules that do not function in a dysfunctional market causing a hit to the bank’s capital requirements.
The answer is to break the cycle and recreate a vibrant mortgage market by creating reasonable loans to qualified individuals that the market can in fact “bank”on.
Most people do not want to walk away from their homes and want to avoid foreclosure at all costs. Answers involving forcing banks to take a capital loss on the loans and refinance with a lower equity value seem motivated by a desire to punish the bankers and can result in a windfall to homeowners. It seems tough to justify forcing the lenders to absorb the losses caused primarily by a market collapse, particularly when market collapses are often followed by a return of value. This is particularly true of the real estate market which tends to run in 10 to 15 year pricing cycles. It is almost inevitable that in 10 years most if not all homes will reach or exceed the values attributed at the peak of the last real estate rice boom. Accordingly, the most efficient answer is not the forced recognition of losses now, but a system which allows people to stay in their homes with mortgages they can pay and allow tie to address the value issue.
To accomplish this, the treasury should create a mortgage reparation plan utilizing the GSEs they now control. The Treasury should dedicate about 300 Billion of the remaining bail out funds to capitalize Fannie and Freddie Mac. These funds will be the entities capital base to address liquidity/confidence issues. The GSEs would then offer special mortgages to persons who: 1) currently have a mortgage other than a 15 year or 30 year fixed mortgage; 2) are not more than 2 payments behind on their current mortgage; 3) are living in the home in question as their primary residence; and 4) can establish an ability to afford the payments on the new mortgage. The terms of the special mortgages would designed to assist affordability: They would be 45 year mortgages offered with a rate fixed for 15 years at a fixed rate based on current market rates, and after 15 years the rate would reset at the then current rate. Qualification would be based on ability to pay under those terms. The loan amount could not exceed current mortgage debt (i.e., no “cash-out” loans) and the loan would be available without reference to the home’s current value.
The 45 year term would lower monthly payments substantially to make the mortgage affordable. The fixed rate would alleviate the problems of adjustable rate resets. The loan is fair to the homeowner because they are able to stay in their home with an affordable monthly payment. They are not forced to take the loss in home value occasioned by market conditions, nor is the bank. Banks would get capital infusions as mortgages are paid off. The number of foreclosures should then move toward more normal levels. With time, the market would reflate, and the homeowner could refinance or sell at their leisure. Under this scenario, most of the special mortgages would not reach the 15 year rate reset, and for those that did, the homeowner would probably have more and better options than are available today.
The GSEs, solvent and with a restored market confidence would be able to float bonds supported by the new mortages, and backed by the 300 Billion capital infusion which would be dedicated as a capital reserve for the mortage program. Once in place, the program should allow the bleeding to stop and permit time to heal the wounds our housing market and financial system has suffered.