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Tuesday, July 29, 2008

Merrill's Mortgages and the Corrupt Dodd/Frank Bill

Those that support the $300 billion bailout created by the Dodd/Frank have justified the bill using two faulty premises. Supporters of the bill refuse to call it a bailout for two reasons.

1) They claim that while borrowers will get new more affordable loans, these borrowers will now have to share their equity with FHA. While this is true, it is also misleading. That's because these borrowers almost always have no equity currently. Let's take an example. Let's say we have a borrower that owes $300,000 on a property worth $250,000. This bill will lower their balance to somewhere in the neighborhood of $225,000. Now, they will have $25,000 in equity but when they sell they will have to split that equity with FHA itself. Of course, this is nothing short of a boondoggle for any borrower that has been irresponsible. Sure, they now only own fifty percent of their equity, but fifty percent of something is still more than one hundred percent of nothing.

2) Banks will have to take a write down on their mortgages. That's true. In this same example, a bank would have to sell their $300,000 mortgage and only get $225,000 back. This may at first appear to be punitive. Yet, let's look what is happening to Merril Lynch's mortgage portfolio.

Yet the investment bank posted a $4.9 billion loss just two weeks ago, in a quarter in which it revealed $9 billion in writedowns.

Merrill has agreed to sell $30.6 billion of its repackaged debt, known as collateralized debt obligations — generally suspect and subprime mortgages — for 22 cents on the dollar. Private equity fund Lone Star Funds is the buyer.

Now, it should be pointed out that Merrill's case is extreme and so other banks would likely get more in the open market. That said, the difference between what they will get from FHA and what Merrill got from the market is quite significant and thus there is no doubt that FHA will offer all these banks, Countrywide and BofA included, a deal they would never get on their own.

As I have often pointed out, Bank of America received a very depressed price when they bought out Countrywide. That's because Countrywide was also holding on to a large portfolio of loans. These loans would also likely get a similar price on the open market to that of the Merrill Lynch backed mortgages. Now that Dodd/Frank has passed, the new entity will likely receive somewhere in the neighborhood of 3 times for these loans over what they would have received in the open market.

This is the sum total of this corrupt bill. Both the borrowers and the banks are receiving treatment we are NOT supposed to give to folks that act irresponsibly.

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