Congress To The Rescue

Oh great, we're all waiting for Congress to "save us" from ourselves in terms of a Bailout Package to deal with bad mortgage paper.

The history of where we are is long and undistinguished. It all started with Jimmy Carter's signing into law the Community Reinvestment Act of 1977, expanding the charter of Fannie Mae and Freddie Mac to increase home ownership. Bill Clinton also got into the act in 1995 and 1998, pushing for further home ownership, as well as the beginnings of the "sub-prime" segment of the market. George W. Bush called for further home ownership for lower income people in 2005. Along the way, efforts to put a lid on Fannie Mae and Freddie Mac were thwarted-- bills to address the oncoming threat posed to the system failed in Congress in 2003 and 2005.

With all of this, we now see the disastrous effects of relaxing the loan underwriting process, including "no doc" loans to people who were under-qualified to make a home purchase. Then we saw the rise of the "zero down payment interest only Adjustable Rate Mortgage", followed by the "negative amortization ARM". These work fine as long as home values are rising, and as long as interest rates do not rise; unfortunately the exact opposite occurred.

The United States is a country built upon credit, and periodically we undergo a financial crisis, a credit bubble, irrational exuberance or whatever other term we want to use. But the reality is that it is *not* irrational to borrow heavily when interest rates are so low; the Fed was basically begging people to borrow. In fact, on a 6% fixed rate mortgage, once you subtract the tax savings on the mortgage, and then subtract the inflation rate, the government is practically paying us to own a home. When home values go up, local tax revenues go up too; when people quit their jobs to flip houses, Federal tax receipts go up. Our long history of pushing the "dream" of home ownership has finally caught up with us, and the message is: there's no free lunch.

And as much as I am opposed to a bailout or rescue package, the alternatives look pretty grim. If the Paulson plan were implemented, Congress would basically take hold of $700 Billion of bad mortgage paper, create a market for it, buy credit-starved institutions some time and liquidity, and eventually (probably) sell the mortgage paper at a later date for a profit. The estimate is that the $700 Billion would buy about $2 Trillion in bad paper (i.e. 30 cents on the dollar). To a market guy like me, this looks like the "trade" of a lifetime, and one that could not only work, but put a huge positive number back into the Treasury at a later date. However, it has to work politically, with checks and balances (not a bad thing). But we're 34 days away from a Presidential election, and therein lies the rub.