Understanding the mortgage bailout runs a lot deeper than the government simply buying bad mortgages from lenders and putting the on the tax payers shoulders. In fact, the government may even be able line its pockets with trillions of dollars that would once again show the resiliency of the American economy.
The issue that currently faces banks and mortgage lenders is that they have assets on their books that have become illiquid because they are continually falling in price. Even if borrowers are current on their home loans, by regulation the lender would have to take a loss on the loan reducing its capital.
The two options for banks are either to hold on to the performing loan through maturity to recover its capital or take a big loss by selling the loan to investors for pennies on the dollar. No matter how you cut it the banks still is not recovering any capital in the short term in order to make new loans. As banks are unable to raise capital the economy starts to grind to a halt.
The governments proposed $700 billion bailout would put the government into the mortgage business as it would purchase these assets for cash and receive mortgage payments from homeowners.
The process begins with banks and mortgage lenders deciding which loans they would like to sell to the government. From there the Treasury decides on which loans to purchase and for what price, which is where the dilemma comes in.
As a taxpayer, you would want the government to purchase these loans at the lowest possible price. However, that hurts banks with more write downs and less capital which is the situation they are currently in. On the other hand, if the government purchases the loan for 100 percent of the value it was lent at, then taxpayers are paying the difference between the homes purchase price and its current depreciated value.
In order to make this transaction beneficial to both the banks and taxpayers, the government would value the mortgage at the borrower's capabilities of paying back the loan over the life. This doesn't necessarily mean the government will hold onto the loan until maturity but rather sell the loan to investors once the market has recovered.
No one believes that the taxpayer will be on the hook for the entire $700 billion bailout the government is proposing. In fact, some economists say that if the cards fall right this $700 billion investment could turn into a $2 plus trillion dollar asset.
Learn more about the mortgage bailout by visiting Future Planning Financial.
Comments(5)