Mortgage Mods: A Modest Proposal to Avoid Moral Hazards
Citing the work of two Wall Street veterans, Thomas H. Patrick, co-founder of New Vernon Capital, and Macauley Taylor, principal at Verum Capital, the plan Morgenson mentions calls for refinancing all the nonprime, performing loans held in privately issued mortgage pools (except for Fannie's and Freddie's) at a lower rate. "The mass refinancing could have helped borrowers, while retiring mortgage securities at par and thus helping pension funds, banks and other investors in those pools recover paper losses created when prices plummeted," she writes. "Fannie Mae and Freddie Mac could have financed the deal with debt." Maybe I'm just far too cynical, but ... how is this not moral hazard of the first order?
The idea is a credit risk swap wherein banks exchange the shaky credit of the subprime residential borrowers -- many of whom possess adjustable-rate mortgages -- with the full faith and credit of the United States government. Remember that the borrowers Morgenson, Patrick and Taylor want to refinance are all nonprime, even if they all are currently up to date on their payments.
So, if I'm a big hedge fund that plowed $1 billion into subprime mortgages back in 2006, I'd get fully repaid on the investment -- even though in the private market those securities might be worth 65 cents on the dollar. If I'm a subprime borrower who couldn't afford to buy the house I'm in, except with a subprime or Alt-A adjustable-rate loan -- because my credit and debt-to-asset ratios weren't good enough to qualify for a conventional 30-year-fixed -- I'm rewarded for having bad credit by the government, which hands me a 30-year fixed-rate loan. For that matter, if I'm a speculator who only took out high-risk Alt-A loans to finance my portfolio of properties in Las Vegas, as long as I've been current on my payments so far, I get the benefit of the government-backed 30-year loans.
Sure looks to me like moral hazard.
Here's a better plan. Call it the Hahn modification of the Patrick-Taylor plan:
Seeing as how Patrick and Taylor are so certain, I say that they put together a new fund with all of the Wall Street banks who think this plan is a great one and would help them get these horrible mortgages off of their balance sheets. Let's call it the Saving American Housing Fund. It should also be a requirement that Morgenson and the editors of The New York Times be among the investors. Now, none of these parties have to put up a dime, because the Fed will loan this Saving American Housing Fund $1.1 trillion at, say, 1.25 percent (the current federal funds rate plus 50 basis points). But this $1.1-trillion loan will be a full-recourse loan, putting at risk the personal assets of all of the individuals and institutions who participate.
Even at today's 30-year-fixed rates of around 4.5 percent, making a 3.25 percent spread seems like a pretty good deal to me. Since there are no losses to taxpayers unless these refinanced mortgages took a hit later on, then there are no losses to Saving American Housing Fund and its principals unless they take a hit, right? Why, it's like guaranteed money for them! Except, of course, they -- instead of the taxpayers -- have to take the risk.
If their idea works, they end up even more fabulously wealthy than they are now. Private risk, private gain. And the Treasury gets paid a premium over and above the federal funds rate, thereby helping restore the national balance sheet over time, as well. The taxpayer is at risk, of course, if the Saving American Housing Fund blows up. But we'd be at risk the other way, as well. So what's not to like?
I hereby call upon Patrick, Taylor and all of the Wall Street titans, as well as their funds, banks and others to pledge themselves and their fortunes on the Saving American Housing Fund. The country needs bold ideas, as Morgenson so rightly pointed out.
Or... we can just let the market function and let things take their due painful course.
It's up to you, brave captains of finance, and heroic champions of editorial opinion! Lead on! We shall applaud your bold steps from afar, and wish you every success, for by your risks, you will help pull the country out of this crisis. Go forth!
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