Brief Overview of Bailout Plan

From Realty Times on September 29, 2008

Washington Report: Overview of Bailout Plan by Kenneth R. Harney


There's no question what's been dominating debate in Washington -- the Treasury's and Congress's plans to buy hundreds of billions of dollars of distressed mortgages from lenders and investors.

The fine print rules and regulations for the bailout plan won't be known for weeks, but here's a quick overview from a real estate perspective on how it's supposed to work:

At its core, the plan is all about taking home loans off lenders' and investors' books that are currently illiquid -- they can't be sold, or are extremely difficult to sell -- because no one is sure what they're really worth.

Consider this hypothetical example: Say you own a mortgage-backed bond that has 100 subprime home mortgages in it. At the moment, 24 of those loans are delinquent; but 76 are paying on time. That proportion is pretty close to reality, according to the latest delinquency numbers from the Mortgage Bankers Association.

Now, because there are serious defaults in the pool, there's a stigma attached to your subprime bond. The best offer you've heard is maybe 20 cents on the dollar - which is ridiculous because over three quarters of your loans are paying on time, and the monthly cash flows should be worth a lot more.

You need an organization or program to intervene, buy your mortgage pool for a fairer price. That, in turn, will allow you to take in some cash and make some new mortgages.

The buyer of your loans can now work to see whether the interest rates, monthly payments, and other features of the 24 “bad” mortgages can be modified to be more affordable for the home owners involved.

Let's say that over a period of three years, those modifications end up saving 15 of the 24 delinquent mortgages from going into foreclosure. The new owner of the pool now has 90 loans paying on time, making it a lot more valuable than it paid.

Although the example is simplified, it's pretty much what the bailout plan is all about: Taking undervalued assets, holding them for awhile and turning them into better assets -- lemons into lemonade -- and reselling them, maybe even at a profit.

It's not clear at the moment how successful this will be long-term. But by buying up incorrectly valued mortgages at a “fair” price, the government has a chance to pump new money into the market -- money for new home mortgages -- and even lower interest rates in the process.

Exactly how to do that -- with what rules and guidelines -- has been what all the noise in Washington has been about.

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