Subprime Conspiracy Theory

By now you have certainly heard that the Federal Government is taking steps to help those poor borrowers of subprime mortgages who were duped by banks and mortgage brokers. I’ll refer to this plan as the “Subprime Bailout Plan”. They plan to help as many as they can refinance into more “secure” fixed rate mortgages, and to freeze the adjustable rate for those who cannot refinance. This plan required many varied interests coming together, and they did so under the guidance of Treasury Secretary Henry Paulson.

At the same time and also with the help of Secretary Paulson, the major money center banks in the US are putting together a plan to finance the purchase of certain assets from Structured Investment Vehicles (SIVs). I’ll call this the “SIV Bailout Plan”. Word is that these vehicles were the repositories for pieces of mortgage securitizations, although finding any actual data on these has been an exercise in futility. The basic idea of this plan is to find a financing source for these assets other than the current structure because the current structure no longer works since these assets have been or may be downgraded by the rating agencies. Once they are downgraded, the SIVs liquidate selling the assets in the marketplace. Because the market for these assets is terrible and sales at current prices would produce large losses, the plan provides a purchaser (the MLEC or Super SIV) for these assets. With time, hopefully, the actual cash flows from these assets will be sufficient to repay the financing used to purchase them at above current market prices. The accounting for all of this raises serious questions in my mind, and if you are interested in that part of it you can read my previous post on that topic here.

To the conspiracy part:
Now, I am not making any direct accusations here, but I would like to point out an issue that I believe should be scrutinized carefully. If the assets in these SIVs are indeed mortgage backed securities or in any way tied to subprime mortgages, then the Subprime Bailout Plan is related to the SIV Bailout Plan because refinancing the subprime mortgages and/or fixing rates for a period of time provides both cash in the form of full repayment of these subprime loans to the owners of those loans, and time to work out the other loans that would default if the interest rates adjust. So, the Subprime Bailout Plan and the SIV Bailout Plan are related, and are both being structured with the assistance of the Treasury Secretary. This raises a potential conflict of interest regarding which subprime borrowers actually receive the assistance that the Subprime Bailout Plan is to provide because those whose mortgages are owned by SIVs or impact repayment on SIV assets could gain preference to aid the SIV Bailout Plan. I believe there should be a call for oversight and full transparency of this entire mess because there is the appearance of a potential conflict of interest here.

Unfortunately, that’s just the beginning of the “conspiracy”. Lets follow the mortgage refinancings to see where the risk of all of these defaults is going. Unfortunately, that road leads indirectly to the federal government and, ultimately, the taxpayer. HUD currently plans to refinance approximately 300,000 subprime mortgages raising serious questions about the ability of the Mutual Mortgage Insurance Fund to adequately cover potential future exposure. Any shortfall in the fund would result in a taxpayer liability. If you would like details about this, you can read my post on it here.

The other place many loans appear to be going is The Federal Home Loan Banks. These banks issue bonds backed by the full faith and credit of The United States (that would be us, the taxpayers) and use the proceeds to purchase mortgages from banks. How much do they purchase, you ask? Well, from December 31, 2005 to June 30, 2007, outstanding advances went from $619.8 billion to $640.0 billion. From June 30, 2007 to September 30, 2007, advances went from $640 billion to $824 billion, an increase of $184 billion. Humm. That would be an annualized rate of increase of ($184 x 4) $736 billion! Senator Schumer has recently questioned the quality of the loans being purchased in an open letter to Ronald A. Rosenfeld, Chairman, Federal Housing Finance Board. You can find that letter here.

Lets review. The Treasury Secretary has developed a plan with major financial institutions to move beaten down assets relating to subprime mortgages (we think) to a Super SIV to buy time to try to liquidate and recoup the value of these assets. At the same time, the Treasury Secretary has developed a plan to refinance and/or freeze the interest rate on some 1.2 million subprime mortgages. The refinance portion of this plan relies on FHA guarantees, and we don’t really know how many subprime mortgages are being refinanced through ultimate sales to The Federal Home Loan Banks. The United States taxpayers ultimately back both of these sources. So, is this really a plan to help those poor victims of the big bad banks that made these subprime mortgages or is this really a bank bailout disguised as a plan to help homeowners? I don’t know the answer, but I know I have serious doubts and there should be some oversight of this entire mess.

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