I am reading an interesting article by Caroline Baum called Paulson Goes to Washington, Loses Way. In many ways her article is similar to what I wrote in Paulson’s Plan Is Nothing But Lip Service.

However, I missed one critical point she raised:

The way these CDO structures are set up, defaults in underlying mortgages trip certain triggers that serve to protect senior noteholders.

If the plan inhibits defaults, “the cash flows that should be reserved for the AAA holders will end up going to the residual owners,” Joshua Rosner [managing director at Graham-Fisher & Co., an independent research firm in New York] said.

“Treasury is pushing a plan that could cause more losses at already weakened Fannie and Freddie.”

With the above in mind, please consider Fannie Cuts Dividend, Offers $7 Billion in Preferreds.

Fannie Mae, the largest source of money for U.S. home loans, cut its dividend 30 percent and said it will sell $7 billion of preferred stock to bolster capital as the housing crisis deepens.

The worst housing slump in at least two decades will hurt fourth-quarter earnings “in a material way” and continue to weigh on 2008 results, Fannie Mae said. Fannie Mae said last month it had a capital cushion of $2.3 billion after reporting a quarterly loss of $1.4 billion.

So Fannie and Freddie are getting clobbered and in need of capital infusions, but Paulson comes out with a program that all but guarantees more losses. Unfortunately, the “fix parade” does not stop there. No Sireee. Please consider Subprime Rate Five-Year Fix Eyed by U.S. Regulators, Lenders.

One challenge will be to craft a deal minimizing lawsuits from investors in bonds backed by the mortgages being rewritten, analysts said. The longer that lower rates are extended, the more risk posed to the bonds’ values. Republican Representative Mike Castle of Delaware has proposed legislation offering a “safe harbor from legal liability” to mortgage servicers.

Sheila Bair, chairman of the FDIC, has been working with Paulson and said she favors extending introductory rates for between five and seven years.

Paulson said in his speech that the government is focused on helping subprime borrowers who can afford the introductory mortgage rate but not the adjusted one. The plan “does not, and will not, include spending taxpayer money on funding or subsidies for industry participants or homeowners,” he said.

Lawyers’ Free-for-All

Hells bells, why stop at seven years? Why not twenty-two or even fifty? And while we are at it, let’s rob the mortgage owner of his right to opt out of the plan by passing a “safe harbor from legal liability”.

Republican Representative Mike Castle as well as Hillary Clinton (See
Hillary Clinton and George Bush: Two of a Kind) are acting to prevent what Caroline Baum spoke of as a “Lawyers’ Free-for-All”.

If you think getting mortgage servicers and investors to agree on an outcome is tough, just wait until the lawyers get involved.

“The modification of existing contracts, without the full and willing agreement of all parties to these contracts, risks significant erosion of 200 years of contract law,” said Joshua Rosner, managing director at Graham-Fisher & Co., an independent research firm in New York.

Does anyone really believe Paulson when he says “The plan does not, and will not, include spending taxpayer money on funding or subsidies for industry participants or homeowners.”?

Fix on top of fix on top of fix are being proposed and none of them will work because it is in the best interest of those underwater on their loans to make sure the plan fails. And if that was not bad enough, Fannie Mae and Freddie Mac are going to be negatively impacted by the bailout and one of the proposed fixes does not even seem constitutional.

Things sure are not going well for Paulson in many ways as More Banks Abandon Paulson’s Super-SIV Plan.

The saving grace of Super-SIV is the free market will have acted before the bureaucrats have time to mess things up even more. All that remains now of Super-SIV is the cover-up of Citigroup’s losses.

Unfortunately, the mortgage mess is quite different. Bureaucrats have plenty of time to make an awful situation worse. And that they will do, with Paulson acting as head cheerleader. To say Paulson “lost his way” is quite an understatement.

Mike “Mish” Shedlock
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