Friday, April 2, 2010

There's a Lot of Ruin in a Nation

New mortgage mod plan continues the wealth redistribution from middle class taxpayers to banks

Recently the Obama administration announced a new mortgage modification plan, designed to reduce the outstanding principal owed by homeowners who were at risk of default. The announcement was greeted with little fanfare and some skepticism, since previous efforts at mortgage modification had met with minimal success. A big part of the problem has been that financial institutions are unwilling to make mortgage changes that force them to recognize damages to the value of their mortgage backed security (MBS) portfolios.

Remember, these MBS's are the securitized instruments that caused (at least proximally) the global financial system to freeze up when everyone realized how poor the lending standards behind the individual mortgages had been. When trillions of dollars in MBS packages plunged in value, the American banking system became basically insolvent, as the value of bank assets shrunk below the level of their liabilities. Since that time, the US government has been using a wide swath of programs to hide the degree of bank insolvency while frantically transferring wealth from the US taxpayer to banks. In order to buy time while the wealth transfer was enacted, the government strong armed the financial accounting standards board (FASB) into modifying mark-to-market accouting rules, allowing banks to carry damaged securitizations on their balance sheet at values above what they would bring in the marketplace.

Of course, changing an accouting value is not the same thing as changing the true value of an asset. Banks were still sitting on these toxic loan packages as homeowners continued to default and home prices continued to decline. Eventually the true worth would be known unless the housing bubble could be quicky reinflated, which isn't likely despite the government's valiant efforts using OPM (other people's money). So now, as Ben Bernanke has wound down his contribution of $1.25trillion purchases of MBS, another government agency has stepped up to the plate to continue the fleecing of middle class. In an article on The Market Oracle website, Mike Whitney explains the new source of taxpayer largesse for bankers:

"Here's how it works: The new program offers incentives to banks and other deep-pocketed investors (in mortgage-backed securities) to slash the principal on underwater mortgages which keeps people from strategic default or foreclosure. Sounds good, right? But here's the catch: When the mortgage is refinanced, it's converted into a FHA-backed loan which provides an explicit gov-guarantee. So, for a slight loss on the face-value of the MBS, the investors (ie--investment banks, hedgies, etc) are able to resuscitate their moribund securitizations (MBS) and reap hefty gains. It's like taking Fido's steaming pile on the front lawn and turning it into the Hope Diamond. Abracadabra!"

Loan guarantees are an especially obnoxious form of government spending, because taxpayers don't even realize it happened. No assets are held in reserve to back up these new liabilities, because unlike the private sector the government just says, "Hey, we have a printing press, we're good for it". These new FHA obligations won't show up on most national debt counters. They won't even result in new taxes, or complaints about greater budget deficits. They'll just be buried deep in the bowels of the FHA, off balance sheet...until they blow up again. That's the reason the bankers love this program -- mortgage mods are proven to redefault in high numbers because a lot of these toxic mortgages were never close to being viable loans. They were based on house price appreciation that didn't happen.

So now, by taking a small haircut on individual loans, banks will see their loan portfolios and MBS gain in value as they become incrementally backed by FHA guarantees, courtesy of working Americans who had no involvement with either side of the loan. And when the financial institutions inevitably call on the FHA to fulfill those guarantees, our already unpayable debt will go up or our central bank will print more dollars to fund the gap. No matter which, this is just another form of dollar debasement waiting for us down the road. As Adam Smith said, "Young man, there's a lot of ruin in a nation". The US government, in their fervent quest to socialize risk, is searching high and low for new sources of ruin to bestow upon our people.

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