What many who are resistant to this plan, in my opinion, don't understand is that the number of firms that could have gone under last week pretty much included everything but the food and drug stocks.
The world revolves on credit and confidence. Both disappeared last week, and the reason behind that is simple: foreclosures.
Let's go over the nexus again. Banks can't lend and are fearful to lend. Why? So much money is tied up in failing mortgages throughout the system that the banks don't have the capital even if they want to lend.
We need a market for this stuff, by ZIP code, by vintage, by loan-to-value, by geography. The SEC refused to insist on this, the bank examiner won't give it to us, so Treasury has to give it to us.
The presumption is that these mortgages are worthless. Chris Matthews said on tv the same thing last night.
That's just not true. If you wrote even the worst mortgages down, if you were to value them at, say, 50%, think of it. You buy a house for 100% loan-to-value for $300,000, roughly the average price of a home in California in 2006. The average house price has fallen 25% from when that house was built. Let's say that it is 33%, factoring in the last month and the skyrocketing foreclosures. Now the house is worth $200,000. The mortgage is for $300,000. You bid 50% for that mortgage, $150,000, then you have a mortgage that's realistic.
You want to get that mortgage current, so you renegotiate the terms. I don't like principal adjustments, but I do like interest rate adjustments. Let's say for the next year, we say, "You are forgiven" for a year, maybe even two, and then you go low-interest for the next five years. That keeps the person in the house. That means that a foreclosure is averted, one less home on the market.
You multiply that over and over again -- and keep in mind that a 100% loan-to-value California house is about the worst other than the piggyback loans that were made with home equity that went to 120%, but I believe in the last two years those people have already been foreclosed -- and you get a firmer market. A firmer market means house price depreciation ends. If house price depreciation ends, then if the home is sold, the mortgage gets paid back and then some. That's where the profit comes in for the government.
Now, you don't have to write these down to 50% to make this work, as you see from the math. You could do it higher.
The thing you need to know is that banks holding these mortgages are either valuing them much lower -- as in Merrill's (MER) pricing to Lone Star, or the writedowns that Bank of America (BAC) has taken and that Wells Fargo (WFC) is taking -- or too high, a la Washington Mutual (WM) . Either way you could either price these so it is in the interest of an acquirer to buy WM and write the mortgages down and then sell them to the government, or have Bank of America sell them and write them up to build earnings.
Either way, the banks can loan more and get the economy's oil flowing again. They can't unless they have a market for these mortgages.
That's why this is so important.
Now, there are certainly issues. How do you keep BAC from making so much money off you and me? We can craft some sort of equity stake that the taxpayer can take. The executives' benefit? We tax it or regulate it. We need to worry about the winners later; let's worry about the loser now, which is the U.S. economy.
Oh, and let's not forget what else goes right if the plan is approved. We get a real boost to the damaged portfolios of Fannie (FNM) and Freddie (FRE) , which we own now. The values could go up big, the foreclosures on those properties go down, and these two go profitable off their guarantee fees, which are gigantic. Or how about the bank owners of CDOs, impossible-to-value instruments that have to be worth more if housing simply stops depreciating or even starts increasing. That takes the pressure off all of the insurance that AIG (AIG) wrote on these, which gives the U.S. government still one more windfall. All of these occur if this plan succeeds.
I am hoping that Warren Buffett, who totally gets the plan, is going to be listened to by Congress. I hope they listen to how important he knows it is and how we will revert to last Thursday's obliteration and destruction, which I believe could wipe out probably a fifth of the S&P 500.
The math is pretty simple. The fact that there will be some winners who shouldn't win is a price we have to pay. Until this plan, everything that Ben Bernanke tried was piecemeal and designed to avoid any scrutiny. Until this plan, the government has simply been reactive to the damage, damage done in part because of a philosophy that pervades this administration, that a market unregulated is a market that is perfect.
This is the first plan that might cost us nothing and solves the problem, and yet this is the plan that gets the most resistance.
If this plan fails, I want nothing to do with this market except for the foodbank stocks. Sounds like Warren Buffett doesn't, either.
I am worried about the plan. It cannot be nickel and dimed. We cannot let Washington Mutual, the next Lehman, fail. We see what happens -- the unintended consequences of Lehman are still roiling us. We cannot have the largest savings and loan go down.
We also cannot have the commercial paper market go away, which is what the major industrial companies live by. All of these will happen in this country if the plan fails.
I have become convinced that we have been hurtling toward Great Depression Two without a resolution of the mortgage crisis.
This is the best way to stop that Great Depression. It would be shocking to me if we went into a Great Depression with foreclosures spiking, home prices plummeting, deflation rampant and unemployment doubling or even tripling, all because we worried about what institutions will make money. The ones who make money are the good ones, as I demonstrated with the math. The bad ones get swallowed up and management booted. What more can you ask for?