Will it Work?

The other day I mentioned that I thought the bailout was a good thing if it works. I will be the first to say that I am about as accurate at predicting the future as most people: I have very limited success! So I decided to research the “if it works” theory by tapping some bigger and better brains than my own!

I spoke with my current Finance Professor, Dr. Christofi, and he is skeptical. He agrees the government had to do something, but feels the real culprit of the mess was FASB 157 – Fair Valuation. For those that have not taken accounting, this rule basically forced companies holding mortgage-backed securities to take a loss and write down their value because the price they could sell their securities for dropped (even though the hold till maturity value was still mostly there). This removed company’s liquidity and made them a higher credit risk. No loan for you, bond holders want more assets, and security holders sell. Ouch!

My old economics professor, Dr. Pressman, feels that the bailout does not provide enough money to really fix the problem. Sure it will add a little liquidity juice, but it will not be enough. Look at what AIG said: “We need to more money.” Of course if you throw $400,000 parties, you would probably need more money too!

So should we throw more money at the financial institutions? Dr. Pressman says no. That does not treat the root cause of the problem: Mortgages. Now my take on that is we unfortunately have to bail out the people who made really poor decisions and bought houses they could not afford.

Sorry if you are one of them, and this may sound harsh, but what were you thinking? I could have gotten a loan for more than twice what my mortgage is. I could have gotten a really low adjustable rate with low payments too. Did I? No. I knew rates were low and they would most likely go up. I also knew my budgetary constraints and the fact that if something sounds too good to be true, it probably is. But hey, housing prices always rise so there is no risk, right? No, wrong. Anyway, I truly hope you get your mortgage issues resolved.

Enough on that tangent, back to Dr. Pressman. He said if the ARMs adjust upward, you would have many more people just walking away from their homes and devaluing the hold to maturity value of the mortgage-backed Securities. Why?

First, they won’t be able to afford the new payments. Second, they will owe more than the house is worth. While he thinks the market will probably stop its death spiral around 7,000 to 7,400, if the ARMs adjust up, the market will go even lower.

I still want to get another economist’s view on the subject: Dr. Scott. He will add the dimension of gaming theory and oil pricing to the overall analysis. He is a really fun guy to talk to and knows his stuff. More to come…