No easy answers --- the mortgage market "solution"
The government's plans to provide relief to home mortgage holders who need it has the right intentions and may be the best choice among a set of alternatives that all carry negatives. Apart from the "moral hazard" issue that Rick Santelli had his 15 minutes with, there is another issue that will have a more tangible negative impact on the economy.
Allowing individual courts to reset principle and terms of mortgages will further depress the value of already stressed mortgage securities in the market. Requiring Fannie and Freddie to refinance mortgages without the mortgage insurance required under their rules will also negatively impact these securities. No investor wants to buy securities that have no certainty, no rules. There is already almost no secondary market now for these securities and there will likely be none soon. Their only value is that most continue to be pools of assets that are continuing to pay the contracted rate of interest on the security. As the judges start ruling and then some percentage of the mortgages refinanced by Fannie and Freddie default, mortgage securities will over time default as well.
One might ask, why does anyone care. The buyers of mortgage securities were big boys, they are paid to understand risk, and they should lose money. If these actions help stabilize the mortgage market and the economy, that's nothing but a good thing.
There is, however, one problem. Retail investment banks and asset managers chopped these insitutional mortgage securities up into bite sized pieces to sell to individual investors, just regular middle class investors up to the high net worth bracket. Much of the selling was done to retirees on a fixed income due to the relatively high yields. Who cared if the individual didn't know the difference between a CMO and an HMO. The yield was good and, same old story, when real estate prices kept going up the yields were solid and the prepayments were quick, underscoring to some that these were actually short term assets.
The result now --- when these securities begin defaulting there will be a different set of the population that becomes increasingly stressed. Help one group, hurt another, there are no painless answers.
Allowing individual courts to reset principle and terms of mortgages will further depress the value of already stressed mortgage securities in the market. Requiring Fannie and Freddie to refinance mortgages without the mortgage insurance required under their rules will also negatively impact these securities. No investor wants to buy securities that have no certainty, no rules. There is already almost no secondary market now for these securities and there will likely be none soon. Their only value is that most continue to be pools of assets that are continuing to pay the contracted rate of interest on the security. As the judges start ruling and then some percentage of the mortgages refinanced by Fannie and Freddie default, mortgage securities will over time default as well.
One might ask, why does anyone care. The buyers of mortgage securities were big boys, they are paid to understand risk, and they should lose money. If these actions help stabilize the mortgage market and the economy, that's nothing but a good thing.
There is, however, one problem. Retail investment banks and asset managers chopped these insitutional mortgage securities up into bite sized pieces to sell to individual investors, just regular middle class investors up to the high net worth bracket. Much of the selling was done to retirees on a fixed income due to the relatively high yields. Who cared if the individual didn't know the difference between a CMO and an HMO. The yield was good and, same old story, when real estate prices kept going up the yields were solid and the prepayments were quick, underscoring to some that these were actually short term assets.
The result now --- when these securities begin defaulting there will be a different set of the population that becomes increasingly stressed. Help one group, hurt another, there are no painless answers.
posted by John Borden at 3:12 PM
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