Now that the Bush Fat Cat Bailout has failed, we need to re-examine the needs of the financial situation and what should be done.
First, a word of thanks to my neighbor for the bulk of the strategy outlined here. The final formulation is mine, so don't blame my friend.
Now, what needs to be accomplished:
- Restore liquidity to the financial institutions.
- Establish the value of the mortgage backed security instruments at the heart of the crisis.
- Clear the housing market of mortgages that are in default, or likely to go into default.
Item number one is the putative reason for the Bush Bailout. But throwing money at the banks on Wall Street merely makes Foie Gras. The Goose gets stuffed, and the only thing that comes out is s**t.
Nevertheless, liquidity needs to be re-established in order for businesses to borrow and thrive.
If the second item can be accomplished, the first item will result from the re-established value of the securities. My neighbor suggests that no more than 15% of the loans in any given mortgage instrument is susceptible to default. If a value can be established for those 15%, then the value for the entire instrument becomes known.
If number three can be accomplished, we would then have a baseline for determining what a defaulted mortgage was worth. However, item number three cannot happen at the moment because of item number one.
It seems that the players in the current bailout are willing to drop $700 Billion on the problem. We all recognize that its a number pulled out of the ether, but its a number. So lets try the following.
Commit up to $350 Billion each to Fannie and Freddie. The strings are as follows:
- Create a new collection of class A mortgage backed securities.
- These mortgages would be on first or second homes. No rental properties.
- Appraise the home being sold at today's market value.
- Provide an interest rate based on Loan to Value (LTV). If the LTV is 50%, 5% 30 year fixed; LTV of 60%, 5.25%; LTV of 70%, 5.50%; and a maximum LTV of 80%, 5.75%. No LTV higher than that.
These steps accomplish the following. First, institutions with funds to invest would be willling to buy the new class A mortgage backed securities because the value was known. Freddie and Fannie (and the American Taxpayer) get their money back. Within a foreseable timeframe.
Second, even if a home that is in default is sold as a short sale, it will get sold because there is now a new pool of funds from Freddie and Fannie to make the sale happen. This will allow the market to clear the existing excess inventory in the housing market. Further, it will put cash back into the banking and investment institutions as the bad mortgages are retired.
Assuming that the sale is short by 30% (not unreasonable). This means that there is a 30% loss on the original mortgage. Further, since no more than 15% of the mortgages in the current ill-liquid mortgage backed securities, this means that the cumulative loss to any one security package is probably no more than 4.5%. This means that the value of these securities can be established at 95 cents on the dollar. Let the institutions that bought these gambling instruments take the hit.
The end result is that much of what was an unknown Liability turns into a known Asset. This will do much to relieve the liquidity problem.
We thus can resolve all three of our objectives, without giving any money to the Gamblers and Fat Cats on Wall Street.
And it is done by operating at the level of Main Street.