Author: Aldon Hynes

Yesterday, a friend pointed me to Public Marketup, a website where citizens can read proposed legislation and add comments. It is a wonderful site, and currently has the Treasury Department’s proposal for ‘Authority to Buy Mortgage-Related Assets’ as well as Sen. Dodd’s proposal.

When I first started reading it, I added comments here and there about making reports available online. However, as I’ve thought more and more about it, I worry that no one really knows what they are talking about. What assets are being considered? How will the Treasury determine which assets get considered? To the extent that they are complicated derivative instruments, how will the Treasury determine an appropriate price?

Reading through the documents, I don’t find any real discussion of this. The Treasury Department of the bill says,

The Secretary is authorized to purchase, and to make and fund commitments to purchase, on such terms and conditions as determined by the Secretary, mortgage-related assets from any financial institution having its headquarters in the United States.

Are we talking about whole loans? Pools of mortgages? Tranches of collateralized mortgage obligations (CMOs)? The extremely complicated portions of CMOs called residuals that take financial wizards to analyze? Collateralized Debt Obligations (CDOs) that have mortgage related assets in their structure? Servicing Rights on securities?

How will these securities be priced, when purchased, on an ongoing basis and if every offered for sale? How will the determination be made about which company’s assets will be purchased? Will it be those companies most likely to fail? Will it those companies whose executives are close friends of people in the administration? Will it be fair?

How will these purchases really make the financial system more secure? The further the assets are from the homeowner, the less effect it will have on a home owner. If the underlying mortgages are bought, and home owners in danger of foreclosure were given better refinancing opportunities or opportunities for short sales, that would have a direct effect on the homeowners. However, it might accelerate the decline in housing prices, as people who otherwise cannot sell their houses are now given a chance, which might compound the situation. On the other hand, that might get us out of the housing bubble sooner.

The Dodd bill is much broader,

The Secretary is authorized to establish a program to purchase, and to make and fund commitments to purchase troubled assets from any financial institution, on such terms and conditions as are determined by the Secretary, and in accordance with policies and procedures developed by the Secretary.

It isn’t limited to mortgage related assets, nor must the financial institution have its headquarters in the United States. Yet other limitations are added instead.

The Secretary may not purchase, or make any commitment to purchase, any troubled asset unless the Secretary receives contingent shares in the financial institution from which such assets are to be purchased equal in value to the purchase price of the assets to be purchased.

This makes the valuation of these extremely difficult to evaluate securities all the more important.

The Dodd bill does move in the direction of seek explanation about why we are doing this in the first place:

Before establishing a program under this Act, the Secretary shall make a finding that such program is necessary to provide stability or preventing disruption to the financial markets or banking system; and to protect the taxpayer.

Although, even this seems a tad vague, and perhaps a little bit after the fact. Maybe this finding needs to be presented in testimony before any such bill is considered.

The Dodd bill also has language about ‘Assistance to homeowners and localities’ and ‘Minimizing foreclosures’, but it starts drifting into legalese beyond the scope of this article.

So, must we move now as the Federal Reserve Chairman and the Treasury Secretary are urging? What sort of movement is appropriate?

Perhaps, we must move now, but perhaps that movement is getting everyone to start reading proposed legislation and thinking much more about the economic issues our country faces. If we move now, slowly and deliberately, we can all learn, and perhaps not fall into the traps that got us into this mess in the first place, making decisions without understanding the full ramifications of them.

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