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Thursday, November 20, 2008

More on Bailouts

The latest mortgage bailout proposed by the Administration is lighter than the New York Times believes (Foreclosure Prevention Lite, New York Times, November 13, 2008: A28).

Nearly all of the plans so far require an adjustment to the mortgage. None of these plans solve the problem of the phantom derivatives (monetized mortgages, credit swaps, and insurance contracts) built upon the shaky foundation of bad mortgages. An adjusted mortgage will a lower face value than the original or with a lower interest rate, and longer term will not create the income stream that the initial owner of the security expected. The price of the security will decline and the banks and insurance companies will only be a little better off than they are now.

The thing to do is make the mortgages whole. To his credit, this was suggested by Senator McCain during the campaign. This will be expensive and it will, alas, benefit the people who sold these mortgages, the foolish people who took out these loans, and the even more foolish people who bought the securities. But this may be the only way to stabilize the world financial system.

They way for the government to do this is to enter a partnership with the homeowner who is at risk. The homeowners will pay what they can afford on the mortgage, the government will pick up the rest. As the mortgage is paid down, the homeowner and the government will build up equity in the home and when the home is eventually sold, the homeowner and the government will share in the proceeds proportional to their total investment. If the house is sold when the outstanding mortgage is still greater than the sale price, the mortgage will have to be rolled over to the new owner under the same terms.

Sent to the New York Times

This is the only way to get out of the mess and it is unfortunate that the government has spent several months on the unsuccessful Plan A, B, and the most recent Plan C which will meet the fate of its predecessors: too little, too late.

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