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Why Bailout Money Should Have Gone to Underwater Homeowners

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Many agree that housing was a cause of the current economic morass, yet, ever after the bailouts, 24% of all homes with mortgages are underwater. Any use of taxpayer money should directly benefit taxpayers.

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Editor's Note: This article was written by Robert Barone, head of Ancora West. Mr. Barone currently serves on AAA's Finance and Investment Committee which oversees $5 billion of investible assets.


The words "Maiden Lane" evoke two completely different reactions when they're spoken at family get-togethers, like July 4th.

1. Great joy and excitement on the part of the female family members imagining a shopping spree at San Francisco's famous Union Square where a street named "Maiden Lane" sports several high end boutiques;

2.
Disgust on the part of the family members involved in the financial sector, as "Maiden Lane" is the name of three LLCs established by the Federal Reserve Bank of New York (FRBNY) and used as vehicles to bail out Wall Street.

"Bailouts" seem to be the norm nowadays, not the exception. Today, the Fed's balance sheet is pregnant with the results of such bailouts. Maiden Lane, LLC, the first one established in March 2008 to bail out the stockholders and bondholders of Bear Stearns, holds substandard collateral valued at $28.4 billion. As of July 1, no cash has flowed to the Fed from this collateral; so imagine how substandard this collateral must be. The Fed says it values the collateral at "fair value," which it defines in its footnotes as "the price that would be received upon selling an asset if the transactions were to be conducted in an orderly market." This could be Fedspeak for "mark to model".

Maiden Lane II, III, AIA Aurora, and ALICO Holdings are the collateral now on the Fed's books associated with the AIG bailout. Note that the collateral, valued again at "fair value" ($64.4 billion), is far less than the $182 billion it took to save AIG. As a reminder, the FRBNY, for reasons known only to God and a few other God-like individuals, decided to pay AIG's credit default swap counterparties at par despite the fact that the market value was closer to 40%-60% of par. (For a complete discussion of the circumstances surrounding these decisions, see The Unholy Washington-Wall Street Alliance).

Table 1: Selected Balance Sheet Entries Federal Reserve Consolidated Statement


Table 2 shows who benefited. Note that foreign banks received $48.2 billion. If the assets they held were worth 60% of par value (as AIG was certain to fail), America's taxpayers involuntarily gave these foreign banks a gift of more than $19 billion.

Table 2: Major Recipients of Par Payment of AIG's Credit Default Swaps


Table 2 also shows that three major American institutions received $24.9 billion, of which $10 billion was a gift from an unaware American taxpayer. (It should also be noted that states received $7 billion as holders of AIG paper.)

The Fed's Venture Into MBS

Looking further into the Fed's balance sheet, there's an entry for $1.1 trillion of mortgage-backed securities. These aren't carried at market values. The Fed says these are carried at the "current face value of the securities which is the remaining principal balance of the underlying mortgages." The reason that the Fed gives for carrying them at face value is that they're "guaranteed by Fannie Mae (FNM), Freddie Mac (FRE), and Ginnie Mae." As a result of not reporting these at market value, the quality of these assets is unknown. But, what we do know is that Fannie Mae and Freddie Mac are bankrupt. Late last December (Christmas Eve day), the Treasury announced that it would guarantee Fannie and Freddie debt through 2012. Without knowing whether such a guarantee will be continued after 2012, it doesn't appear appropriate to be carrying such mortgages at face value and relying on the bankrupt institutions' guarantees. (At this time, it appears that continuing Congressional support is likely, but it isn't certain, and two years can be a long time in the political arena.) What would the accounting profession and the SEC do to a listed company that carried debts of financially troubled companies at face value when market values exist?

The Ultimate Cost of Fannie and Freddie

Since Fannie and Freddie have now appeared in the discussion, the American taxpayer, to date, has contributed $145 billion to their support. Technically, Fannie and Freddie have borrowed these funds at a 10% interest rate. The $14.5 billion annual interest bill amounts to more than their combined revenue streams in their best years. Estimates for the eventual cost of Fannie and Freddie vary between $290 billion and $1 trillion. Given the state of the housing industry and its prospects for the next few years, the higher number appears to be more realistic. Table 3 is a tally of the bailouts to date. While taxpayers might get some of this back via the collateral and perhaps some eventual debt repayment, most of this is a loss. That is, a loss to taxpayers.

Table 3: Tally of Bailouts

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No positions in stocks mentioned.
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