As the attention in Washington, D.C. is on a Treasury Department proposal for a $700 billion bailout of major lenders, West LegalEdcenter and West Legalworks are providing some free resources for anyone involved in the mortgage and asset-related securities market to learn more about the bailout proposal.
First, a free white paper titled “The Impact of Securitization on the Legislative Proposal for Treasury Authority to Purchase Mortgage-Related Assets” was just written by Talcott J. Franklin.
He is the co-author of the Mortgage and Asset Backed Securities Litigation Handbook from West, and is a partner and head of litigation in the Dallas office of Patton Boggs LLP.
“Everyone has questions and anger with respect to who caused this mess and why no one acted sooner,” Franklin writes.
“But the fact is, we have to act quickly to reduce the impact of this crisis. When Americans act together, we can overcome every challenge, and we will overcome this one. But if we fall into partisan bickering and the laying of blame, if we are motivated solely by self-interest and not the overall good, if we act rashly and without careful thought, the crisis will grow, as will the sacrifice required to remedy it.”
Franklin adds, “This paper takes no position on whether the Treasury Proposal should be adopted, only that it can be improved. Many excellent points have been raised during the course of the hearings on the Treasury Proposal. This paper points out some additional issues for consideration.”
In addition to the free white paper, a free live webcast titled “Bailout or Washout: An Analysis of the Treasury Proposal to Purchase Mortgage-Related Assets,” will take place Monday, Sept. 29, from 1 p.m. to 2 p.m. Eastern.
The webcast will address a number of questions, including:
- What would the Treasury own if it bought mortgage-backed securities?
- How will the oversight mechanism of Treasury’s investments operate?
- What are the benefits of the proposal? The risks?
- What will determine the success or failure of this plan?
- How will the taxpayers be compensated for their investment?
The webcast will feature Franklin, the Hon. Chris Bell – a former member of Congress and member of the House Financial Services Committee – and Thomas F. Nealon, Franklin’s co-author of the Mortgage and Asset Backed Securities Litigation Handbook. Nealson is general counsel at LNR Partners, Inc.
Again, you can download the free white paper here and register for the free webcast here.
Outline of Proposal for Handling the Liquidity Crisis
Three Basic Objectives
1. To prevent a progressive collapse of the US economy, liquidity must be injected into the mortgage system.
2. No Resolution Trust Corporation this time.
I was involved with the Resolution Trust Corporation the last time and the government should avoid taking on this responsibility this time. Banks, through their mortgage and REO departments, are much better at handling negotiations with mortgagees concerning staying in the properties and paying reduced mortgage amounts, foreclosures if necessary, maintenance and upkeep of the properties after foreclosure, and resales. Objective #2 will be justified in greater detail at the end of this working paper.
3. Officers and stockholders of organizations bailed out by government should suffer severe financial consequences, to assuage moral hazard and for the perception of equity on the part of the population.
Alternative Solutions
1. Government loans to the companies, secured by the company’s assets, à la AIG.
2. Government purchases of new stock offerings, which have a priority call on the assets of the company.
3. Government purchase of newly issued convertible, which have a priority call on the assets of the company.
Any of these three would be acceptable, but I would prefer number three.
The major question is how much to pay. Like AIG, leaving the stockholders with about 20%, as opposed to nothing, seems about right.
Another approach toward determining an appropriate price might be to require that new stock or convertible bonds be issued, say 30% be sold on the open market at a given price sufficient to clear the 30% offering (like a typical new stock offering), and the government guarantee to purchase the remainder at half the given price. This would set a market price for the stock, given government support, and give the government the extra benefits it deserves.
Why should the government get the benefit of a 50% discount? Because the government may be the only entity capable of saving some of these companies. Without its investment, the deal could not happen. So, in fairness, the government, i.e., the people, should benefit from that fact, as opposed to other stockholders. In this case the government is playing the role of a large investment business and should be remunerated consistent with that role.
Without government investment the companies are worth nothing. But with the government bailout, the companies should be worth a lot and just compensation for the government should be about 80% of that increase in value.
This approach to the injection of liquidity should enable the government, in the long run, to do much better than breakeven . The political benefit from such an outcome, or even the valid projection of such an outcome, at this moment, would be enormous.
Additionally, if some of these “failing” companies see that the deal they get from the government is not very attractive, they may miraculously figure out how to handle their own problems or find an alternative White Knight which is not as greedy as the federal government; in either case, a desirable outcome.
How Much to Appropriate?
I have heard that $700 billion was calculated by assuming 5% nonperforming mortgages and simply multiplying 5% times the total value of all US mortgages. If true, the government shouldn’t need anything close to that. This would be a huge pot of money just waiting to be stolen.
$700 billion assumes 1) that all dicey mortgages are worth zero (no income and no asset value in the real estate) and 2) that the companies will go bankrupt if they don’t receive the full original value for these problem loans. Both assumptions are ridiculous.
If all such loans were completely nonperforming, the mortgage holders would be losing a total of about $55 billion per year in income. How does that require an injection of $700 billion?
Of course, it’s not quite that simple because nonperforming mortgages must be carried on the balance sheets at a very low value, decreasing the creditworthiness of the banks. This is only an accounting figment and does not represent reality. The real estate is still there and it has value. Nevertheless, even neglecting the value of the real estate the amount of injection required to clean up the balance sheets might be another say $45 billion, bringing the total to $100 billion.
The $700 billion request, further assumes that the companies had no margin for error. Most companies should be able to lose 5% of their income and yet take corrective action to avoid bankruptcy. Some companies may be holding well above 5% problem loans and they will need more liquidity. But then, logically, others must have less than 5% and they will need less or no help from the government.
Let’s see how they spend the first hundred billion dollars and then go back to Congress if necessary.
Regulations
As Mark Cuban pointed out, in less colorful terms, any regulations developed by Congress will have their locks picked by the smart guys on Wall Street before the president’s ink is dry. I think Mark Cuban and Sarah Palin, working separately, came up with a great insight, transparency through the Internet.
If all transactions are published on the Internet, the government doesn’t need a huge regulation law nor a large regulation bureaucracy. The population will do it. I know that having the people know what’s really going on scares the hell out of most politicians, but I hope and believe that both of the presidential candidates are different in this regard.
Objective #2, Further Explained
2. No Resolution Trust Corporation this time.
(I moved the further explanation of Objective #2 away from the beginning of this working paper because I didn’t want to detract from the efficient presentation of the most important aspects of the working paper.)
a. Many congressmen are concerned with fair and reasonable treatment of mortgagees. The Federal Government is usually a very blunt instrument for dealing with individual problems which require judgment and flexibility. The banks may not be wonderful in this regard, but they would indubitably be better.
b. If the government did buy the problem mortgages, it would be very difficult to determine an appropriate price. Such a process would present great opportunity for sloth on the part of government employees, deception on the part of banks, and graft on the part of everybody.
c. If the government had to set up its own mortgagee negotiation, foreclosure, maintenance, and sales departments; the cost would be much greater and the performance would be much worse than banks, who already have such departments.
d. The maintenance and upkeep of vacant properties is always a major problem, but the government’s performance in this area would doubtless be inferior to and more expensive than that of banks. The losses to vandalism, copper thieves, and normal deterioration would be prodigious.
e. In the 90s, prime Resolution Trust properties were scooped up at bargain prices by well-connected fat cats. I was high bidder on three of the lesser properties, but didn’t get even one. Corruption and backdoor dealing were rampant. My attorney indicated that, the way the whole thing was set up, it would do me no good to take legal action against the corruption. Government is inherently subject to this kind of problem and banks generally are much less so.