Subprime Bailout

Sure, leave it up to the government to come up with a questionable plan to solve part of the Subprime crisis by proposing a temporary freeze on scheduled interest rate increases for certain home owners.

Michael Shedlock’s article “Temporary Mortgage Freeze Is Doomed” sheds some light on the plan and its implications. Affected will be certain borrowers who had chosen to take out a ridiculously low introductory rate and are now facing a reality check via a rate adjustment. Keep in mind that many of these borrowers had no business to get a loan in the first place, since most ‘qualified’ only via the “fog up the mirror approach.”

Now they need to be bailed out? I have to agree with Mike that the true reason behind this proposal is the fear that many banks are not in a position to take back any more undervalued real estate. It might bring down the very institutions that created this Subprime problem in the first place with their lax lending standards. I am not an economist, but it seems to me that freezing borrower’s payments for a number of years will not solve the problem, it will merely postpone it.

First, government bailouts have never worked in the past. Second, someone is holding these securitized mortgages at a value far less then what was paid for because of the questionable valuations of the underlying security. I am certain that part of the value was determined by the fact that these mortgages would adjust at a certain point in time. If this scheduled increase gets postponed, it would seem that their value would be even less than it currently is. Who will be taking those losses?

Well, most likely it will be banks, hedge funds and other institutional investors. You’d think that this would be a real problem, but as long as they don’t have to mark their assets to market, at least on paper it appears that they are still viable institutions. But, sooner or later, somebody has to pull his head out of the sand and face reality.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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