The $8 Trillion Dollar Bailout
NEW YORK (CNNMoney.com) — Sitting down? It’s time to tally up the federal government’s bailout tab.
There was $29 billion for Bear Stearns, $345 billion for Citigroup. The Federal Reserve put up $600 billion to guarantee money market deposits and has aggressively driven down interest rates to essentially zero.
The list goes on and on. All told, Congress, the Treasury Department, the Federal Reserve and other agencies have taken dozens of steps to prop up the economy.
Total price tag so far: $7.2 trillion in investment and loans. That puts a lot of taxpayer money at risk. Now comes President-elect Barack Obama’s economic stimulus plan, some details of which were made public on Monday. The tally is getting awfully close to $8 trillion.
The amount of $8 trillion is incomprehensible to most people, including myself. But there is an interesting way to contemplate the amount of $8 trillion dollars. The total amount of home mortgage debt outstanding in 2008 amounted to only $10.6 trillion (see Mortgage Holiday). If the government had simply used the $8 trillion to directly payoff consumers’ mortgage debt, all of us could have seen an 80% reduction in our mortgage payments! Go figure.
As Congress debates legislation to empower the Treasury to purchase troubled mortgage-related assets, some are trying to weigh the bill down with ancillary, unnecessary provisions. The one which concerns us the most is a provision that would allow bankruptcy judges to unilaterally change the terms of many mortgage loans, including the loan balance, as part of Chapter 13 bankruptcy proceedings. By granting judges this power, this bill would throw into question the value of the collateral that backs every mortgage made in this country — the home.
The fact remains that the lending community remains united against this idea. It is our position that if this proposal were to become law, mortgage rates would increase by at least one and a half points. In addition, lenders will be forced to require higher down payments and charge higher costs at closing. All these increased costs would be necessary to account for the new risks that lenders will face when judges decide to change how much borrowers owe on their mortgages.
Interest rates are correlated to risk – that’s the way things work in a free market. If a mortgage loan is made with the risk of principal mark downs in bankruptcy, this risk has to be priced into the loan rate.
During the bailout vote, Democratic Senator Dick Durbin of Illinois argued for the right to give bankruptcy judges the ability to change the terms of a mortgage. With the change of power in Washington, the odds of mortgage cram down legislation passing is very high.
Since total mortgage delinquencies are less than 10% and not all of these cases will wind up in bankruptcy, cram downs might help less than 5% of mortgaged homeowners. If the MBA is correct and mortgage rates rise significantly due to cram downs, expect a significant backlash from the other 95% of mortgaged homeowners who will wind up paying for the losses through higher interest rates.
Mortgage/Treasury Spreads Reflect Risk
Bloomberg) — Federal Reserve officials are focused on driving down the spreads between U.S. Treasury yields and consumer and corporate loans, after cutting the main interest rate to almost zero failed to revive lending.
Credit costs for households and businesses haven’t followed yields on government debt lower. Fifteen-year fixed-rate mortgages were at 5.06 percent last week, 2.59 percentage points above 10-year Treasury yields; the spread averaged 0.88 point in 2003, when the Fed slashed rates to 1 percent.
Chairman Ben S. Bernanke sees the thawing of frozen credit markets as critical to a recovery, and is determined to try to prevent a second wave of credit distress as the U.S. weathers bad economic news over the next two quarters. The Fed is now looking at ways to revive lending by using its balance sheet to hold loans and bonds that investors don’t want.
“Investors in general don’t want to take on the risk,” said Richard Schlanger, who helps manage $15 billion in fixed income securities at Pioneer Investments in Boston. “It is going to reach the point where the Fed will intervene again.”
If spreads between treasuries and mortgages followed the historical norm, mortgage rates on both the 15 and 30 year mortgage would be at least 1.5% points lower. The question that is not addressed, of course, is how much higher would mortgage rates be without government price support? Since private buyers see a poor risk/reward ratio in owning mortgages, does the government establish a permanent presence as mortgage lender of last resort?
In addition to providing price support to mortgages, we now have a Federal Reserve pledging to bring down consumer and corporate lending rates as well. The announcement that the Fed would be buying mortgage backed securities brought down mortgage rates. Can the Fed do the same in other debt markets by purchasing securities that free market investors view as too risky to own?
With the Fed extending its purchases into virtually every asset class, a question comes to mind. As the Fed assumes the losses of all the failing economic entities in the country, at what point does the US Government begin to share the credit quality of those they are bailing out?
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