Thursday, September 25, 2008

Guest Blogger John McIlwain: This Is Not Your Father’s Bailout

There is a lot of talk this week about the RTC and even about the New Deal Reconstruction Finance Corporation Reconstruction Finance Corporation. Understandable. People are trying to say that, well, we’ve worked through lots of bad debt before and so naturally we can do it again. Just give the $700 billion to the Treasury, they’ll hire some managers and consultants, and Bob’s your uncle, as the Brits would say.

Well, maybe not. In fact, this will be a whole new animal with a whole new set of challenges. To name a few:

  • The RTC took over the assets from failed banks. This new effort will have to buy the assets. The lower the price, the safer the deal for the taxpayer, while the higher the price, the more likely the bailout will work and provide the needed credit pump priming – an interesting tension, and no one yet has said how it will be resolved.
  • By a very rough calculation, the $700 billion could acquire some 2.8 million single family mortgages.That’s a bundle.If you’ve ever worked for a mortgage servicing company, you know how much paper that is.And you know as well that every servicing company has their own software (often several different software packages as they often acquire other services) and NONE of them are compatible.Just getting the data to one place and one format will take years.
  • But most of what will be bought will not be mortgages but parts of various tranches of mortgage backed securities (MBSs), commercial mortgage backed securities (CMBSs), collateralized debt obligations (CDOs) made up of MBSs and CMBSs, and structured investment vehicles (SIVs) made up of all the above. No one knows what is in most of these pools, and heaven knows where the documents are. In time, with enough effort, most of the documents will be found, but not for some time and not all of them – witness the cases where special servicers have been trying to foreclose on a mortgage without original documents, usually unsuccessfully.
  • There will be little opportunity to work out the mortgages that make up the pools on which the securities are based, or even to modify the mortgages to help the homeowners, as many people are understandably recommending.Without owning the vast majority of all the tranches of a particular mortgage pool, the Treasury (or its agents) won’t be able to modify the contract with the special servicer in charge of the assets (the mortgages) in the pool.So the servicers will still have to follow their contracts and foreclose on defaulted loans instead of modifying them.Well, sure, the Treasury could buy up all the securities based on the pool – if it can find who owns all of them, and if it can find a price at which all the holders want to sell.But unless it owns enough securities, it won’t control what happens to the mortgages.It could try to override the pool documents and take over control, and perhaps this is one of the reasons the Administration proposed that nothing they do could be reviewed by a court or administrative agency.But this is highly problematic.
  • It is probable that every large and mid-sized accounting firm, law firm, mortgage servicing firm, and anyone else who can argue that they have expertise in the area of buying and selling mortgages and mortgage securities are getting ready to get a piece of the $2 to $3 billion a year in fees the Treasury will be paying out to make this bailout work. Hopefully, the Inspector General of the Treasury is also planning to hire a whole lot of extra auditors; this is going to be a larger contracting operation than the Iraq war (and, if the Administration gets its way, without any obligation to follow any federal contracting rules or requirements).

In short, the Congress is being asked to create a massive and totally unprecedented effort in the space of a week while no one has any idea how to make this work. Talk about jumping off a cliff!

John K. McIlwain is chairman of NHC's research affiliate the Center for Housing Policy, and a senior resident fellow at the Urban Land Institute where he holds the ULI/J. Ronald Terwilliger Chair for Housing. Prior to joining ULI, McIlwain served as senior managing director of the American Communities Fund for Fannie Mae, and was president and CEO of the Fannie Mae Foundation.

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