It has been about two weeks since enactment of the bailout legislation and the details of implementation are just beginning to emerge. Officials have announced that the Commercial Paper Funding Facility will buy short-term corporate, but not municipal debt, and that the U.S. Treasury will spend $250 billion of the Troubled Assist Relief Program funds to purchase equity interests in banks.
These initiatives are authorized under the provisions of the bailout legislation, the latter essentially an "elastic clause" that define as a "troubled asset" eligible for purchase, any instrument that the Treasury secretary, after consultation with the Federal Reserve chairman, determines the purchase of which is necessary to be purchased to promote financial market stability.
As yet, however, there has been no official pronouncement regarding the troubled assets that are ostensibly the focus of the legislation, i.e., distressed mortgages and mortgage-related securities. As it is widely acknowledged that the residential mortgage crisis is at the heart of our current economic woes, this is surprising.
More than two weeks ago, prior to the release of the first draft of the bailout legislation, I proposed (as described in the Sept. 29 edition of The Bond Buyer) that state housing agencies buy portfolios of troubled mortgages in their respective states with the proceeds of tax-exempt, single-family mortgage revenue bonds. Such bonds would be credit-enhanced under a new federal insurance/guaranty program to be authorized in the legislation.
The suggestion was that mortgage balances would be written down to 80% of face value and the price paid for the mortgages would be 75%, providing a cushion. The homeowners/mortgagor would have a greater possibility of meeting those reduced obligations and the improvident lenders/investors would be allocated some responsibility in the form of the penalty imposed by the writedowns. The Treasury would not have to make a direct expenditure to implement this proposal; its liability as a guarantor/insurer would be contingent.
As to the manner valuing the distressed mortgages, on further consideration I would incorporate the suggestion made by Susan E. Woodward, in her column in the Oct. 14 edition of the Washington Post, that Fannie Mae has the capacity to establish values for existing mortgages. (Woodward was chief economist at the Department of Housing and Urban Development from 1987 to 1992 and at the Securities and Exchange Commission from 1992 to 1995.)
Accordingly, existing mortgages should be restated at values to be established by the model used by Fannie Mae, and purchased by state housing agencies at a slight discount from those values with the proceeds of bonds issued by SHAs. The bonds could be taxable and guaranteed under the bailout legislation, or - subject to volume cap or a new statutory exemption - tax-exempt, with the pool of mortgages, rather than the bonds, to be federally guaranteed or insured, somewhat like some existing FHA programs.
Distressed mortgages are not the entire problem. There is also a scarcity of new credit-making mortgages. The Oct. 7 edition of The Bond Buyer contained an article by Andrew Ward describing the impact of the credit crisis on the issuance by SHAs of single-family mortgage revenue bonds to finance new residential mortgages ("Housing Agencies Forced to Curtail Lending"). Promoting the creation of new, high-quality mortgage loans should be part of the solution to our residential housing problem.
As to new residential mortgages, the SHAs' access to the capital markets could be increased by utilizing the Treasury secretary's power under the bailout legislation to guarantee "troubled assets" in one of two ways:
* Guarantee or insure portfolios of mortgages originally funded with the proceeds of state housing agency single-family mortgage revenue bonds, thereby reducing SHA mortgage portfolio credit stress and permitting SHAs sufficient access to the capital markets so that they could issue new bonds to finance high-quality mortgages.
* Interpret the term "troubled assets" to include the single-family mortgage bonds the issuance of which is currently being curtailed, and use the secretary's authority to insure pools of new mortgages. This might be more of a statutory stretch because of language that could be interpreted as requiring the pertinent "troubled assets" to have been originated prior to March 14, 2008. I think this alternative is preferable from a marketing standpoint, if it could be done.
These initiatives could be undertaken with a relatively small proportion of the $700 billion authorization, but could, nevertheless, have meaningful impact. In addition, this investment would be in the form of a contingent liability, rather than requiring a cash outlay for direct purchases of troubled assets.
Jeffrey Blumenfeld is chair of the public finance practice group at WolfBlock LLP in Philadelphia.
