Bailout Starts In The US In Earnest

The catalyst for higher equity prices appears to be that President Bush will sign Congress’s housing bill, which solidifies support for the mortgage guarantors Fannie & Freddie, both of which are rising sharply. Even troubled banks like Wachovia Corp was up 6.2% after a 29% gain on Tuesday on the back of a quarterly report which detailed major losses at the firm.US Treasury Secretary Paulson was confident that Congress would approve his housing rescue plan this week and so far they are moving forward as planned. The plan is to pass the Housing Bill before August recess that includes provisions to extend credit lines to Freddie and Fannie, Treasury purchase of equity stakes and a new regulator. Bill would extend FHA guarantees to refinance $300 bn fixed-rate mortgages for 400k homeowners w/ negative home equity as lenders take a 15% hair cut on principal; its cost would be recovered by profits of Fannie, Freddie and FHA fees on lenders/borrowers with some adjustments.

• White House: Bill should be financed by (higher) borrower's credit risk-weighted premium paid by lenders/borrowers with strong underwriting standards; Critics: This would reduce size of the program covering smaller no. of homeowners
• CBO: Treasury assistance to Freddie&Fannie and FHLB may cost $25 bn during 2009-10; Housing Bill may cost $2.7 bn during 2008-13 ($1.7 bn for FHA guarantees; $1 bn in administrative/counseling services); can be financed by loan premium of 2% but may result in higher future credit cost; the absence of such assistance may put severe pressure on financial markets and the economy
• Risks: Risk of default due to continued decline in home prices, rise in future interest rates; risk to FHA and taxpayers if riskier loans are refinanced; bleak financial health of Freddie/Fannie, impact on its shareholders
• Paulson: Declining home inventory, stabilizing home sales are leading to price correction and affordability but are constrained by cost and availability of credit; modifying mortgages for credit-worthy homeowners can prevent foreclosure and benefit both lenders and households; 'Covered Bonds' may help reduce cost of financing/refinancing homes
• Bernanke & Kroszner have also supported FHA refinancing w/ lenders writing down principal, large capitalization of GSEs
• Lex: Plan may slow new foreclosures but won't reduce excess home supply as tighter financial sector balance sheets will constrain mortgage financing for households; many mortgages are securitized and difficult to modify; Preference of lenders to modify only 'at-risk' loans may pose future default risk for FHA
• Roubini: Plan will prevent further decline in home prices and loss to lenders, banks, neighborhoods and fiscal cost to govt from foreclosure - cost of debt reduction via debt restructuring much lower than cost of liquidation
• Levitin: Plan not feasible since principal cut has to be taken not by a single lender but by a pool of securitized trusts; second mortgages (w/ large negative equity) also have to be bought out; lenders may offer only low-potential recovery mortgages for FHA refinancing (adverse selection), thus putting taxpayers at risk
• Economist: Plan will be ineffective in preventing foreclosures; Instead fasten foreclosures so that homes can be bought by people who can afford them, streamline state bankruptcy laws
• Ritholtz: Plan will keep home prices artificially high creating market distortions; instead need to speed up market correction and allow home prices to fall so that they become more affordable for others to buy
• Senai: Plan will reduce poorly collaterailized/unviable mortgages for refinanced/well-backed mortgages, but being limited to first homes and 2005-07 period, it will be insufficient to reduce overhang of houses, banks' balance sheet/liquidity problems
• Gross: Plan where burden is shared by all parties is a better alternative than free-fall market clearing, asset deflation, foreclosures

photos: Lee Hyori