Abandon Stupid Policies

Yesterday, the U.S.Treasury announced that they were abandoning their approach to fixing the banking crisis. This is good. It was stupid to begin with.

Here is what they were previously planning to do:

• All of those bad mortgages that had been written with low teaser rates and enormous balloon rates had been split into investment notes and these investment notes were sold to investors from around the world. This is called monetizing the mortgages.
• Individual mortgages were split into multiple notes. So if a single home owner defaulted upon his mortgage, up to 20 notes could be damaged.
• This year everyone holding mortgage notes tried to divest themselves of them., only to discover no one else wanted these investment notes either.
• This caused a freeze up in the cash market.
• The U.S. Treasury was given $750 billion by Congress to buy these notes at retail prices so the investors would not lose everything and the cash market would unfreeze.

Retail Prices?!!

They couldn't buy the notes at their current market value because the value of a $40,000 note was almost zero. Nobody who held them wanted to sell them at zero dollars.

So what value could they pick?

Face value issue price.

The Treasury was planning to buy the mortgage investment notes at the same price they were when they were created, without any consideration for damage done to them by defaulting mortgages.

The investors were going to make a triple profit.

1. They were going to recover their initial principal without participating in any of the cost of the risk.
2. They were going to collect all of the payments made by all of the mortgage holders to date.
3. They were going to foreclose on the properties of the defaulting mortgage holders and resell these properties for at least a fraction of their value.

Who wouldn't want a deal like that?

Yesterday, the Treasury decided they didn't want to participate in this foolishness.

What should the U.S.Treasury do?

They should take their $750 billion and buy the difference between the present value of the homes on which mortgages are held and the value of those properties when those mortgages were issued.

This way a house which was worth $500,000 before the mortgage loan crisis but is now worth $300,000 today would have $200,000 of its mortgaged value purchased from the note holders by the U.S.Treasury.

This tactic will create a lien against that property so when it is sold for any value greater than its bought down value (in the example, $300,000) , the Treasury will collect its investment (in this case, $200,000).

What will this accomplish?

Immediately, the investment notes will provide return of part of their principal to their holders. But investors will still have to participate in the risk of the investment to recover their full value.

Home owners who are being buried by declining home values and rising monthly mortgage notes will find their monthly notes decreasing.

The U.S.Treasury will eventually recover their investments.

Finally, the panic will be stopped and cash will flow again.