Bush’s mortgage relief plan- who pays?

December 8th, 2007

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Recall that Is the worst over yet?, we mentioned about looming wave of housing defaults in the US. Hence,

… there are going to be more adjustable rate mortgages in the US that will have their mortgage rates reset in the coming months. That is, a lot more home loan borrowers will find that their mortgage rates will revert from the ?honey moon? rate to the standard rate. Therefore, more people are going to find that their mortgage expense will shoot up suddenly. When this happens, we can expect the rate of foreclosures and home loan debt defaults going to rise in the US.

But now, as you would probably have heard by now, President Bush has a plan to preempt the escalation of this crisis. In Bush offers homeowners 5-year rate freeze, it reported that

US President George Bush today offered new steps to help homeowners facing steep increases in their mortgage payments, an effort to prevent the US housing crisis sending the broader economy into a recession.

Look at how the stock market reacted in respond to Bush’s plan- it surged almost 200 points upwards on Thursday. Isn’t this wonderful?

Well, no.

There is no such thing as a free lunch. The question is, who is going to pay the bill for the mortgage reset relief? As you may recall in Collateral Debt Obligation?turning rotten meat into delicious beef steak,

After you ?buy? the home loan ?product,? your regular loan repayments are aggregated together with other borrowers? repayments into a tap of cash flow. This cash flow is then sliced into pieces of ?investment? products.

So, no matter how wonderful Bush’s plan may be, someone, somewhere, has to foot the bill. Who are the ones to do so? We can think of two groups of people:

  1. ‘Investors’ of CDO products – If the cash flow from borrowers has to be reduced to help them tide over their un-payable mortgage repayments, then those ‘investors’ of CDO products will have to accept reduced yields on their ‘investments.’ This would mean that the value of their ‘investments’ would have to be crimped significantly to accommodate the crimped yields. Since the values of these ‘investments’ will exist in someone’s balance sheet as an ‘asset,’ then this means there will be further asset write downs.The question is, who are those ‘investors’ of CDO products? They could be you and I!! What??

    Well, almost all of us have superannuations, 401k, insurance policies, bank accounts, etc. How do we know whether our superannuation/401k funds, insurance companies, banks, etc have any kind of direct or indirect exposures to those toxic CDOs? Well, they can assure us all they want regarding their levels of exposure to those CDOs, but can they really be absolutely sure? They can account for their direct exposures (if any) to CDOs, but what about their unknown indirect exposures through their relationships to other financial institutions, funds, businesses, derivative position, etc?

    Mind you, a lot of us are foreigners to the US. For example, some of us could be pensioners in Australia footing the bill of Bush’s plan.

  2. American tax-payers – Bush could tax the American people to pay for his plan. But this will be politically impossible because in a democracy, the mob always want something for nothing. The next best alternative will be through stealth tax- ‘printing’ of money (see How to secretly rob the people with monetary inflation?). This way, the American people will pay through price inflation. That is, they will pay through the further loss of their dollar’s purchasing power.

Between these two groups of people, who do you think will be the chosen one to foot the bill? We doubt it will be the first group because of the risk of further inflammation of the credit crisis. Therefore, the more likely choice will be the second group, which is more convenient for the US government. And it is most likely the second group will pay by stealth (i.e. further debasement of currency through the ‘printing’ of money).

Sure, the stock market may react by rising further. But it will be for the wrong reason.