Is $700 billion spit in the ocean?

The essence of the Paulson Plan is that Treasury, using $700 billion of taxpayer money, will become just another investor in a $7.4 trillion market for mortgage backed securities, as Andrew Jakabovics of the Center for American Progress points out here. If that's a fair characterization of the problem, as it seems to be, it's hard to believe injecting 10% new cash will solve it, especially since the revised Paulson Plan would also allow purchase of some toxic assets that are not MBS.

As Jakabovics points out, MBS are not the problem per se. The problem is that many underlying mortgages are in default, and even the middle tiers of MBS can't be evaluated without reliable estimates of how the mortgages themselves will perform.

Jakobovics suggests Treasury buy up all the tranches of MBS and the servicing rights for particular groups of mortgages and then renegotiate mortgages that can be saved. This is similar to the Paisley (also at Center for American Progress) proposal I mentioned here. I can't imagine how real people in the real world with finite budgets and finite schedules could do that. It seems to me much more practical to revise the bankruptcy code to allow judges to cram down revised mortgage terms. This way, the only mortgages that would have to be looked at would be those of folks willing to file bankruptcy and able to show the ability to pay a renegotiated debt larger than the estimated realization from foreclosure. The financial industry should welcome this, but it turns out they hate it. I don't know why.

Update on Thursday, October 30, 2008 at 08:53AM by Skeptic

Two professors explain here why so few packaged loans are being reworked.  It's because if anyone has the power to rework these loans it's the loan servicers, and the servicers have powerful incentives to do nothing.  The professors propose a non-bankruptcy solution--federal legislation to create a federal trustee to evaluate mortgages and rework those for which a rework would maximize recovery.  The trustee would hire experienced local bankers to do the evaluations and renegotiations, and the federal government would pay the administrative costs. 

Update on Thursday, January 8, 2009 at 01:51PM by Skeptic

The financial industry is withdrawing its opposition to giving bankruptcy judges authority to cram down adjustments in home mortgages.  UPDATE 1/9/09 at 9:40 a.m.:  The Los Angeles Times reports this as a critical breakthrough in removing effective financial industry opposition to the change.  The New York Times doesn't see it as that signficant, but it does report unnamed officials as saying "financial institutions were coming to the conclusion that it might be better to get a reduced loan payment through bankruptcy or voluntary negotiations than to get no money at all."  And it took these geniuses how many months to do that calculation?!

Update on Saturday, January 24, 2009 at 01:42PM by Skeptic

Here's another explanation for lender resistance to giving bankruptcy judges the power to modify loans on primary residences:  A court order would instantly trigger the lender's obligation to write down the value of the asset, an action that the lender may be delaying for as long as possible in order to avoid disclosing how weak its balance sheet is.