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Our thoughts on the “bail out”

Posted on Sep 30, 2008

I was talking with a customer yesterday and they asked me what I thought about the 700 Billion dollar “bail out” of Wall Street using tax payer dollars. Well, I said, I am not an economist, but I think it is a good deal for tax payers. The response from my client was a gasp of surprise. A good deal for tax payers? How could funneling $700 billion to Wall Street be a good deal for us? Well, I said, it depends on how the money is spent. These funds are not designed to just be handed over. The government, thus you and I are buying mortgages from the banks. These mortgages, while underperforming and in many cases are for an amount over the current market value of the property, are backed by REAL property. A house, or condo, a real asset that has value. The governments plan is to buy these mortgages at .40 to .50 cents on the dollar of what the face value is. So lets look at the math really quick. The bank did a mortgage at 95% of the value of a house worth $300,000, so they now have a mortgage at $285,000. Economy is bad, house values decline, buyer can’t pay the mortgage…Now we have a bad mortgage debt that is really hurting the bank and their ability to raise new capital. The government comes in and offers the bank .50 on the dollar for the $285,000 note, or $142,500. Lets say the house has declined 30% from the original value, that means it is still worth $210,000.  The difference is that the Government has a much lower cost basis than the original lender did, thus they are actually in a significantly improved position compared to the bank. 


I also see it possible for the government to renegotiate the rate on these purchased notes, to help the struggling homeowner keep their home. A worse case scenario, the government could force foreclose and easily recoup their cost of purchasing the mortgage.


With that explanation, my client felt as though we actually might be making an investment rather than bailing out the banks that have made bad credit decisions for the past 4-5 years. There is a lot of details yet to be ironed out, but I do believe that this “investment program” was needed, or we could have been facing a far higher price in the very near future.     

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