FDIC and Loan Pools

Washington Report: FDIC and Loan Pools

The Obama administration's latest plans to bring relief to the financial markets have been dominating the news from Washington, but it's far from clear whether they'll actually produce more money for people to buy houses.

Here's why: Although the Treasury's and FDIC's programs almost certainly will help major banks clean some of the toxic suprime mortgages and commercial real estate securities out of their portfolios, that doesn't mean the banks will turn around and extend new mortgages to consumers.

That's because there's no "quid pro quo" in this program. The FDIC and Treasury are essentially helping banks sell off loan pools and securities at discounts to private investors and "public-private" joint-venture funds, but there's no requirement that the banks do anything in particular with the money.

Banks can take the sales proceeds and simply use them to bolster their capital positions. They can also wait for a higher price and sell nothing.

Of course there is a chance that some banks will take the money and plow it into parts of the mortgage market that really need it at the moment, like jumbo mortgages in high-cost housing areas throughout California, in Florida, Washington, D.C., the New York metropolitan and New England.

The Bank of America is leading the way on the move into jumbos -- loans above $730,000. Even without selling its own toxic mortgage assets, it has begun making an aggressive push into big home loans -- offering up to one and a half million dollar mortgages to borrowers with good credit and minimum 20 percent equity. Fixed interest rates are in the high five percent range.

You might ask: why would sophisticated investors have any interest whatsoever in the "bad" loans and securities on the banks' books? Why would pension funds want to buy somebody else's garbage? Here's why. Because those assets are better than garbage. Subprime mortgage backed securities and loan pools owned by the banks might have high rates of default and foreclosure: say 30 percent to 40 percent.

But that means 60 to 70 percent of the borrowers in these securities are still paying on time. The cash flows produced by those borrowers are worth something. And some of the delinquent borrowers may be salvageable through loan modifications and rate reductions.

How much will investors pay for these damaged goods? Since there's a lot of federal guarantees involved in the whole program -- and private investors won't need to put up a lot of equity -- the Obama administration hopes they'll pay whatever is necessary to get the banks to sell.

Written by Kenneth R. Harney March 30, 2009