Consumer Law

Another idea

By Alan White

By Alan White

Instead of buying mortgage-backed securities from banks, Treasury could buy the mortgages themselves from the servicers of mortgage-backed securities at a discount via a reverse auction. As written, I believe the Paulson plan would actually permit this modern version of the Homeowners Loan Corporation. Here's how it would work.

A typical pool of say $500 million in subprime loans now has a third or so of its mortgages delinquent or in foreclosure. If the servicer forecloses, it will likely recover only about 60% of principal on a given mortgage. The servicer might agree to accept 80% of the balance due in a sale to Treasury. A competing servicer might accept 75%, and the lowest bidder would be able to unload its loans at a higher-than-currently-expected return. Once the servicer sells the mortgage, it is treated as prepaid, the loss is realized, and all the mystery about the value of the securities related to that mortgage pool is resolved. All the financial institutions wondering how to value that security will be paid, and can fix the value and stop writing it down. If the servicer loses 25% on one-third of its mortgages, and the other two-thirds are repaid, the pool will lose about 8%. (At 75% or more recovery on the underlying mortgages, the AAA securities will be paid in full, typically, while junior tranches will absorb losses.)

Once Treasury buys a mortgage, it can be restructured, as FDIC is doing with IndyMac mortgages now, and in some cases the homeowner could repay the Treasury the discounted purchase price, or even the original loan amount, while in other cases there would likely be a loss.

How much would this cost? There are about 5 million mortgages now delinquent or in foreclosure, with perhaps another 2 million in danger. Let's assume half of those mortgages (3.5 million) would meet whatever standards the Treasury might set (occupied by a homeowner with a pulse, house is still standing, etc.) Let's further assume that the average balance is $250,000 and the average purchase price @ 80% is $200,000. Let's see, $200,000 times 3.5 million equals . . . $700 billion. Recoveries would depend on the reliability of Main Street in meeting its obligations, not the reliability of Wall Street.

Full post as published by CL&P Blog on September 27, 2008 (boomark / email).