Lawson for Congress

Why would Bank of America, the largest bank in the country, agree to purchase Countrywide Financial, one of the nation’s most toxic mortgage lenders?

Four words: Too big to fail.

You see, the name of the game is bailout. Bank of America really has nothing to lose. After making a $2 billion investment when Countrywide was is distress last summer, anteing up additional stock (it was a stock deal, not cash) to purchase Countrywide and become the nation’s largest mortgage lenders was an easy next step. Think about the options from BoA’s perspective:

After watching its initial $2 billion investment decline by $1.3 billion, and seeing its purchase teetering on the brink of insolvency, it could just watch the mortgage lender keel over, and let someone else to pick up the pieces. That’s not too attractive, as BoA’s initial investment would likely be wiped out in the process.

The alternative is simply to buy the company outright. Does BoA need to worry about “calling the bottom” in the housing market? Does BoA need to concern itself with how much further the housing and mortgage market might deteriorate, and what further writedowns might damage the balance sheet of their combined entity?

Nah. Come on, we’re talking about Bank of America! Get it? It’s the biggest bank in the country. Is failure of Bank of America really an option?

Of course not. Which explains this recent article in the New York Times:

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

It all makes sense now, doesn’t it? If you owe $350,000 on a house now valued at $250,000, the government would pay BoA to purchase your loan, and then reset your mortgage down to $250,000 with a reasonable interest rate. You stay in your house, keep paying interest, and BoA is spared the trouble of foreclosing based upon your negative equity.

Even better, since it didn’t cost BoA anything to put that $350,000 in your account when you signed the mortgage in the first place, they still come out ahead when the loan is bought by the government. But how is the government going to buy these troubled mortgages? Read on:

The government would buy the mortgages at their true current value, perhaps through an auction, at what would probably be a big discount from the original loan amount. The mortgage lenders, or the investors who bought mortgage-backed securities, would be free of the bad loans but would still have to book their losses.

But wait… what is “true current value”? What the government is willing to pay in an auction? Who is bidding against the government? Can you even call it an auction if the banks are selling the mortgage to a single buyer? Who will set the price? The banks, of course. After all, we need to make sure BoA’s balance sheet is adequately protected. So then what happens?

Mr. Taylor estimated the government might end up buying $80 billion to $100 billion in mortgages. But he said the government could recoup its money if it was able to buy the mortgages at a proper discount, repackage them and sell them on the open market.

Oh, I see. The government is going to buy mortgages at a discount, repackage them, and sell them on the open market. That process isn’t working now, but after the government prints more money to give to the banks in payment for the at-risk mortgages and resets mortgages at a more tolerable level for the consumer, presumably the government will be able to sell those mortgages.

That is, as long as the broader credit crisis doesn’t cripple the economy, throw the borrower out of his job, and leave him unable to make any mortgage payments.

To whom will the government sell them? Well, the banks. Sounds like they get to play the game, “sell high, buy low”, with the taxpayer paying the difference.

What a great plan. Is there another alternative? Remember, failure is not an option. We bailed out the banking industry in the S&L crisis of the early 1990s. Sounds like we’re lining up to try again.

Even more amusingly, some savvy consumers are beginning to take advantage of this twisted situation in a new and unique way. Since a large number of mortgages are packaged into securities, and since the brokers securitizing these debts have been playing fast and loose with the loan documents in their rush to package up the loans, borrowers are discovering that they can successfully beat foreclosure when the supposed lender is unable to provide the actual loan note itself:

Joe Lents hasn’t made a payment on his $1.5 million mortgage since 2002.

That’s when Washington Mutual Inc. first tried to foreclose on his home in Boca Raton, Florida. The Seattle-based lender failed to prove that it owned Lents’s mortgage note and dropped attempts to take his house. Subsequent efforts to foreclose have stalled because no one has produced the paperwork.

“If you’re going to take my house away from me, you better own the note,” said Lents, 63, the former chief executive officer of a now-defunct voice recognition software company.

Judges in at least five states have stopped foreclosure proceedings because the banks that pool mortgages into securities and the companies that collect monthly payments haven’t been able to prove they own the mortgages. The confusion is another headache for U.S. Treasury Secretary Henry Paulson as he revises rules for packaging mortgages into securities.

So how will this situation turn out? Time will tell, but we desperately need economic and monetary systems that encourage saving and production instead of borrowing and consumption. Do you really think current trends are sustainable?

This entry was posted on Sunday, February 24th, 2008 at 7:25 pm and is filed under banking, debt, economic freedom, fractional reserve banking. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.