BAILOUT 2.0?Central banks float rescue ideas

Bailing out Bond Insurers was a non starter to get ABX indices off the floor. Now it looks like another plan is brewing. Just in time for elections no doubt.


Central banks float rescue ideas
By Chris Giles and Krishna Guha in London

Published: March 21 2008 22:02 | Last updated: March 21 2008 22:02

Central banks on both sides of the Atlantic are actively engaged in discussions about the feasibility of mass purchases of mortgage-backed securities as a possible solution to the credit crisis.

Such a move would involve the use of public funds to shore up the market in a key financial instrument and restore confidence by ending the current vicious circle of forced sales, falling prices and weakening balance sheets.

EDITOR’S CHOICE
The four ‘new sheriffs’ of Wall Street - Mar-21Lex: Propping up mortgages - Mar-21Gapper: Why Bear’s bankers should make penance - Mar-21Man in the News: Timothy Geithner - Mar-21Editorial comment: Renew the financial toolbox - Mar-17Fear of further casualties whips up new storm - Mar-14The conversations, part of a broader exchange as to possible future steps in battling financial turmoil, are at an early stage. However, the fact that such a move is being discussed at all indicates the depth of concern that exists over the health of the banking system.

It shows how far the policy debate has shifted in recent weeks as the crisis has spread to prime mortgage assets in the US and engulfed Bear Stearns, the investment bank.

The Bank of England appears most enthusiastic to explore the idea. The Federal Reserve is open in principle to the possibility that intervention in the MBS market might be justified in certain scenarios, but only as a last resort. The European Central Bank appears least enthusiastic.

Any move to buy mortgage-backed securities would require government involvement because taxpayers would be assuming credit risk. There is no indication as yet that the US administration would favour such moves. In the eurozone it would require agreement from 15 separate governments.

One argument among policymakers and bankers has been that new international rules have exacerbated the credit squeeze by requiring assets to be valued at their current record lows rather than at face value.

But a strongly held view at one European central bank is that it is not “mark-to-market” accounting that is to blame for severe weaknesses in banks’ balance sheets but that prices of MBS securities have fallen to levels that imply unrealistically high rates of default.

If public authorities were to buy and hold sufficient mortgage-backed securities – rather than simply lend against them as they have until now – at prices well below face value but above current prices, they would set a floor in the MBS market.

The Fed does not believe that the point has yet been reached when such drastic action is necessary and considers the discussions it has had with its counterparts to represent “blue-sky thinking” rather than the formulation of a definitive policy proposal.

Fed officials are monitoring the impact of the latest barrage of Fed liquidity moves and interest rate cuts. They also believe the US has not exhausted all the options short of wholesale public intervention and further intermediate steps are available to them.

These could include still more aggressive use of the Fed’s own balance sheet to boost liquidity in the markets.

Analysts say the US government also has plenty of scope to boost support for the markets indirectly through the Federal Housing Administration or Fannie Mae and Freddie Mac.

The UK lacks these institutions, which could be one reason why the Bank of England is keenest to explore outright intervention. The UK government has already become heavily involved in buying mortgages since September with the recent nationalisation of Northern Rock, the mortgage lender.

Michael Coogan, the director-general of the UK’s Council of Mortgage Lenders, said this week: “Demand for mortgages remains strong but cannot be fully met from existing funding sources.” He predicted higher prices and reduced lending.

It is not just central banks that think the MBS market prices are too low and imply a unrealistic level of mortgage default. Some US states’ pension funds are investing small sums in the mortgage market.

Robert Gentzel, a spokesman for the Pennsylvania State Employees’ Retirement System, told the AP news agency: “Some of the securities that have dropped in value were really very solid securities.”

 

Bank of England Says It Seeks to `Ease the Strains' in Markets

By Dick Schumacher

March 22 (Bloomberg) -- The Bank of England said it is studying ways to ``ease the strains'' in financial markets and denied a report that it's considering using public funds to shore up the mortgage-backed securities market.

The U.K. central bank is ``not among'' those that may propose plans requiring ``the taxpayer rather than banks to assume the credit risk,'' a spokesman for the London-based bank said in a statement read to Bloomberg News today.

``We can confirm that we have been examining a number of other options, but it is too early to go into any detail,'' he said, declining to be identified by name in accord with Bank of England policy.

Central banks from the U.S. and Europe are exploring the feasibility of using taxpayer money to stabilize the market for securities backed by mortgage, the Financial Times said today, without saying where it obtained the information.

The Federal Reserve, the Bank of England and the European Central Bank are at an early stage in discussions that are part of broader talks about how to ease turmoil in the markets, the newspaper said. They are considering using public funds for large purchases of mortgage-backed debt to help prevent bond prices from falling further, the FT reported.

 

Fed's Next Move May Be to Buy Mortgages, Treasury Investors Bet

By Daniel Kruger

March 24 (Bloomberg) -- Forget lower interest rates. For the Federal Reserve to keep the financial markets from imploding it needs to buy troubled mortgage bonds from banks and securities firms, say the world's biggest Treasury investors.

Even after cutting rates by 3 percentage points since September, expanding the range of securities it accepts as collateral for loans and giving dealers access to its discount window, the Fed has been unable to promote confidence. The difference between what the government and banks pay for three- month loans doubled in the past month to 2.03 percentage points.

The only tool left may be for the Fed to help facilitate a Resolution Trust Corp.-type agency that would buy bonds backed by home loans, said Bill Gross, manager of the world's biggest bond fund at Pacific Investment Management Co. While purchasing the some of the $6 trillion mortgage securities outstanding would take problem debt off the balance sheets of banks and alleviate the cause of the credit crunch, it would put taxpayers at risk.

``An RTC-type structure is interesting, and it may not be that much of a burden on taxpayers in the long run,'' said Barr Segal, a managing director at Los Angeles-based TCW Group Inc. who helps oversee $80 billion in fixed-income assets. The government should purchase the mortgages and reissue ``debt that's backed by the U.S. government and there you go, you've unclogged the drain,'' he said.

Bill Rates Plunge

New York Life Investment Management is considering buying ``high-quality mortgages,'' Thomas Girard, a money manager at the New York-based insurer, said. ``At some point here you've got to increase your allocation to non-Treasury securities,'' he said.

Mortgage bonds rallied last week. Yields on the securities fell to an average of 1.25 percentage points more than Treasuries from 1.57 percentage points on March 14, according to Merrill Lynch & Co.'s Mortgage Master Index. The so-called spread is still twice as wide as the average for all of 2007.

Investors, averse to holding most any debt except Treasuries, drove rates on three-month bills to 0.387 percent on March 20, the lowest since 1954. Rates on the securities, the safest assets next to cash, tumbled 0.59 percentage point last week to 0.57 percent. They were as high as 4.29 percent as recently as Oct. 15.

``Something like that would be very helpful, but the Fed was not designed to and shouldn't assume a huge amount of risk on behalf of taxpayers,'' said Alan Blinder, a Princeton University professor and former vice chairman of the central bank. ``That should come out of the elected parts of the government, which means the administration and Congress.''

Resisting Calls

President George W. Bush and Treasury Secretary Henry Paulson have resisted calls urging the use of government funds or guarantees to stem a record amount of mortgage foreclosures, the root of the financial crisis, preferring that the markets resolve the trouble. Bush said March 15 he wanted to avoid ``bad policy decisions'' that would do more harm than good.

President George H.W. Bush, the current president's father, signed the 1989 law which created the RTC to dispose of the assets of insolvent savings and loans banks. From 1986 through 1995, 1,043 savings banks with over $500 billion in assets failed, costing taxpayers $75.6 billion, according to a Federal Deposit Insurance Corp. analysis.

The Fed, the Bank of England and the European Central Bank are exploring the feasibility of using taxpayers' money to shore up the mortgage-backed securities market, the Financial Times reported on March 22, without saying where it obtained the information. A Federal Reserve official denied to Bloomberg News that day that it's in discussions to buy mortgage debt.

Fed Moves

Smaller steps are already being taken. The Bush administration reduced the amount of capital Fannie Mae and Freddie Mac are required to hold as a cushion against losses. The March 19 agreement allows the government-chartered companies, the largest sources of money for U.S. home loans, to expand their purchases of mortgages by as much as $200 billion.

The Fed has also lowered borrowing costs, opened the so- called discount window to investment banks and arranged the sale of Bear Stearns Cos. since March 16 to ease financial-market turmoil. The world's biggest financial companies have posted at least $195 billion in writedowns and credit losses tied to subprime mortgages and collateralized debt obligations as of March 20, according to data compiled by Bloomberg.

JPMorgan Chase & Co. agreed to pay about $240 million for the fifth-largest securities firm in a transaction that includes as much as $30 billion of financing provided by the Fed for Bear Stearns's ``less-liquid'' assets.

`Done That Already'

``In a sense they've done that already with Bear Stearns,'' Michael Materasso, senior portfolio manager and co-chairman of the fixed-income policy committee at Franklin Templeton Investments, said of the government taking on the risk of owning mortgage securities. ``This was not just a temporary situation. The process has begun, the question is how far can it go?''

Franklin Templeton manages $110 billion of bonds. Materasso is based in New York.

A March 13 proposal by Senator Christopher Dodd and Congressman Barney Frank that the Federal Housing Administration insure refinanced mortgages after lenders reduce the loan principal to make payments more affordable to homeowners ``is the next step,'' Senator Charles Schumer, a New York Democrat, said in a Bloomberg Television interview on March 19. It's a ``broader step, but not as broad as RTC,'' he said.

For Pimco's Gross that's not enough. ``If Washington gets off its high `moral hazard' horse and moves to support housing prices, investors will return in a rush,'' he wrote in a note to investors published Feb. 26. Gross, who runs the $122 billion Total Return Fund from Newport Beach, California, didn't return calls seeking additional comment.

An RTC-like entity may not be ``the best idea, but maybe it's the idea that gets us through this,'' said New York Life's Girard. ``The likelihood of it happening has certainly increased.''

To contact the reporter on this story: Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: March 23, 2008 11:00 EDT

 

Unbelievable. What a joke.

 

Bush Readies Mortgage Aid Plan
At-Risk Owners Could Get Cheaper Loans

Sebastian Villalba mows the lawn of a house to be sold at foreclosure auction in Laguna Hills, Calif. (By David Mcnew -- Getty Images)



The Bush administration is finalizing details of a plan to rescue thousands of homeowners at risk of foreclosure by helping them refinance into more affordable mortgages backed by public funds, government officials said.

<b>The proposal is aimed at assisting borrowers who owe their banks more than their homes are worth because of plummeting prices,</b> an issue at the heart of the nation's housing crisis. Under the plan, the Federal Housing Administration would encourage lenders to forgive a portion of those loans and issue new, smaller mortgages in exchange for the financial backing of the federal government.

The plan is similar to elements in legislation proposed two weeks ago by Barney Frank (D-Mass.), who chairs the House Financial Services Committee, officials said. Administration officials said they believe they can accomplish some of the same goals through regulatory changes, though important details have yet to be nailed down.

If enacted, the plan would mark the first time the White House has committed federal dollars to help the most hard-pressed borrowers, people struggling to repay loans that are huge relative to their incomes and the diminished value of their homes. That may offer encouragement to the banking industry and help silence Democrats, who have accused the White House of rescuing Wall Street investment banks while ignoring distressed homeowners. But it could agitate conservatives, who are likely to view the FHA plan as yet another government bailout.

Senior officials in several parts of the administration described the plan on condition of anonymity because the specifics are still being worked out. It is unclear when the plan will be formally unveiled, though one official said it was unlikely to happen before the president returns from a trip to Europe next week.

"The administration for a long time had the idealists and the pragmatists. And because the market conditions are what they are right now, the pragmatists are looking at this and saying, 'How can we achieve something?' And they seem to be having more sway," said Francis Creighton, vice president for government affairs at the Mortgage Bankers Association, which has been working with Frank on his proposal.

The initiative now being crafted could provide relief to a select group of homeowners who are "under water" on their mortgages, a term that describes the situation when falling home prices leave borrowers with negative equity. These homeowners would have to agree to stay in their homes after refinancing, be able to afford the new monthly payments and have lenders who are willing to go along with the plan, officials said.

Administration officials have yet to iron out other details, such as how big the new mortgage should be relative to the home's value.

An estimated 8.8 million households currently have negative equity, due in part to the rise of loans that often required no money down. Negative equity becomes a problem when the homeowner can no longer make mortgage payments. If the homeowner had some equity, the loan could be refinanced or the house could be sold. But a homeowner who is under water cannot afford to do those things because the new loan or sale proceeds would not cover the cost of the existing mortgage.

Treasury Secretary Henry M. Paulson Jr. signaled in a speech Wednesday that the administration was developing an initiative tailored to this specific problem, saying "the people we seek to help" are those who want to keep their homes but are falling behind on their payments. "If they also have negative equity in their homes, refinancing becomes almost impossible and so workouts become even more important," he said. He credited Alphonso Jackson, secretary of the Department of Housing and Urban Development, with helping to craft the plan.

In a recent report, Merrill Lynch identified negative equity as a prime cause of rising default rates, saying borrowers who already have poor credit records are often deciding it makes sense to walk away from their homes when the values fall.

Federal Reserve Chairman Ben S. Bernanke has called on lenders to restructure some loans, arguing that it would be less costly to forgive some debt than to foreclose on the properties.


So far, the centerpiece of the administration's effort to address foreclosures has relied on a private alliance, called Hope Now, to streamline the process for refinancing, modifying mortgages and offering delays for some on the brink of foreclosure. Lenders have been reluctant, however, to offer actual reductions in loan principal.


To spur bankers to action, Frank and other Democrats are working on <b>legislation that would allow the FHA to insure an additional $300 billion in mortgages on which lenders have agreed to accept partial losses. Under Frank's proposal, the new loan could be worth no more than 85 percent of the home's current appraised value. It would also have to meet FHA loan limits, which were raised significantly by the economic stimulus bill recently signed by the president and are currently set at about $730,000 in the Washington area. Homeowners would have to meet stringent eligibility requirements and would be required to share any profits if they sold or refinanced within five years. </b>

Frank estimates that his plan could save as many as 2 million homeowners from foreclosure. Administration officials said their plan is likely to help far fewer people. These officials remain strongly opposed to other elements of Frank's legislation, including <b>a provision to spend $10 billion buying vacant foreclosed homes. </b>

Depending on its final scope, the proposal could further rile conservatives in Congress alarmed by what they see as a new tendency by the White House to interfere with market forces. The Fed's decision to arrange the purchase of beleaguered Wall Street investment bank Bear Stearns by J.P. Morgan Chase -- with the blessing of the White House -- has already generated grumbling.

Earlier this week, Iowa Sen. Charles E. Grassley, the ranking Republican on the Senate Finance Committee, joined the committee's chairman, Max Baucus (D-Mont.), in raising questions about the Bear Stearns deal and demanding information about the role Paulson played in the transaction.

"I've been hearing from the administration that they weren't going to do things" that reward risky behavior. "I want that affirmed," Grassley said. "To the extent that Treasury or the White House was pushing Bernanke to do something . . . that would really disturb me."

Many conservative analysts who oppose government intervention in financial markets nonetheless support the Bear Stearns deal.

Sen. Tom Coburn (R-Okla.) said he hoped that "the administration is not into subsidizing stupid behavior. It's one thing to help people who made a rational decision, who were spammed or defrauded. But it's another thing to reward people who thought they were getting something for nothing, and knew what they were getting into."