Thursday, December 4, 2008

Why This Fed Solution Won't Work

Ben Bernanke wants foreclosure rates to decline. So do I, but it's not going to happen anytime soon. Forbes online explains why. Before I explain, a pop quiz related to this subject: Who owns the mortgage debt of America's homeowners?
a. Mortgage brokers
b. Banks
c. Foreign governments
d. Who knows?

If you answered d., you are correct. Amazingly, telling banks to stop foreclosures is futile because the loans have been sliced between so many different investors, that no one really knows who owns the debt!

From the article:

Who is supposed to take the loss when these debts are reduced? Servicers don’t have any skin in the game, beleaguered lenders who originated the poorly underwritten loans often quickly sold them and the investors who ended up owning many mortgages through sliced and diced securities called collateralized loan obligations would probably be better off with a foreclosure.

Ultimately, the lack of transparency for all parties involved, along with a lack of accountability for bad practices led to the mortgage mess. If an individual homeowner could go back to the holder of the note and re-negotiate, all parties would be better off. But there is no one with whom to negotiate. This mean this mess will be terribly difficult to clean up. I am a firm believer in free markets, but any economist will say that free markets require transparency to operate properly.

Final quote:

The behind the scenes debate over who should take the loss on mortgage workouts is one of the most important issues that U.S. policymakers and lenders are faced with, and one that they are most loath to discuss. This is because unjustly hurting investors would create an alarming precedent that the American government no longer considers a business contract sacrosanct, which runs the grave risk of alienating those abroad who have looked to the U.S. as an investment haven governed by the predictable rule of law.


  1. Slightly off topic: Bernanke is doing all the heavy lifting here. Congress is just dorking around, holding hearings, accomplishing nothing. If I was Bernanke, I'd tell the lot of them, "I quit helping as of now. Until you pass a Balanced Budget Amendment and prove to me we're not going to keep burning money, I'm not going to do one more thing."

    He's got the power, he might as well try to use it.

  2. KT,
    But I prefer Congress just dorking around, in general. Would a balanced budget amendment be nice? You bet, but there are practical problems of enforcement. The only long term solution is education of the public and ridicule of their economic stupidity.

  3. I am in favor of fiscal sanity, but I am against a balanced budget amendment.

    Look what that has gotten us here in California. During "surpluses" the legislature runs wild pigging on pork. Then when the inevitable decline comes they whine there isn't enough money and rather than cutting those gilded lily programs they cut teachers (and other programs the people don't want to see cut) and ask for tax rate increases.

    The federal folks wouldn't be any different.

    THe only way I'd be interested in balanced budget amendment is if it: 1) blocks tax rate increases during shortalls (tax increases can only take effect after a 12 month waiting period), 2) allows for the saving of surpluses during windfalls, and 3) is automatically voided during times of war.