Just who deserves a government bailout?

Published 10:59 am Friday, September 26, 2008

It is not as complicated as you may think, the financial crisis. If you understand the concept of “Smoke and Mirrors” this is all pretty straightforward.

When the Federal Reserve made 1% interest loans available to their clients, the banking community, it was like popcorn at the movies, easy to sell, fun to profit, and quick to move. So all kinds of loans moved into the market, including ARM’s, no down payment loans, and what the industry fondly calls “liar loans” where borrowers simply fudged their income because no one really cared.

The banks loaned money about as easily as they gave out calendars, and the economy prospered…for a while. But when the housing market collapsed, and the loans started to go bad, suddenly there were no buyers and the banks ended up holding the bag, or in this case, the bad paper loans.

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The scheme did work for a while though. The bank would loan the easy money, then re-sell the loans to either one of the five US Investment Banks (all now history or re-invented as commercial banks) or to Freddie Mac or Fannie Mae. If the loans went directly to the Investment banks they were grouped together with other investments, rated for their overall risk, and re-sold as securities to pension funds, foreign investors, mutual funds or even hedge funds.

If the loans went to Freddie Mac or Fannie Mae they were also clustered and then sold on Wall Street to the same buyers as securities. The beauty of the deal was that US home mortgages were the most stable investment in the world, that is, before easy money.

So these mortgages, often based upon overvalued prices, faulty appraisals, poor loan types and unqualified borrowers, moved and sold as though they were actually trusted investments.

But they never were trusted investments. They were packages of loans that never should have been made. So when the housing market collapsed, the loans almost instantly turned bad. That meant, in the industry, that no one would buy the bunched securities. So suddenly the stream from banks to investors dried up, leaving the banks holding the bad loans.

Now banks, unlike Investment banks, have some actual regulations, and have to hold reserve funds for anticipated losses. So if they cannot sell their loans to Investment banks, then they have to gather more money to cover their projected write-offs. If this happens then they have less money to lend. You can see now where this goes…you and I can no longer get a home loan or a car loan because our bank has to save its cash to write off these bad loans.

This is where the bail-out comes in. Now, in spite of what our leaders are telling us matters here, like CEO compensation and tough oversight, what really matters here is what price the government pays for the bad loans. The bad loan securities are already possible to sell, but the banks don’t want the prices they are offered, about thirty cents on the dollar. Should they accept these prices they must write off the other 70% and have the capital to pay for the write-off.

So while we write our congresswomen to tell them we don’t like the bail-out, the banks are flooding congress to get a high price on the securities sales, as high as 100%. Now just who would pay 100% to buy a mortgage of $500,000 on a home now valued at $300,000 with mortgagees who are in foreclosure?

Believe it or not, you and I may do just that.