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Friday, December 7, 2007

More Subprime Theft

I read this story on the Liberty Papers. I already wrote about the Subprime Mortgage Lending Scam, but this story is adding ANOTHER level of outrage.

The government is considering a bailout of people who have subprime mortgages and are at risk of defaulting. There were three proposals circulated. The first is that, even though these are adjustable-rate mortgages, lenders will be barred from adjusting the rate upwards. The second is that the mortgage holders might be allowed to refinance at a fixed-rate mortgage, even if they wouldn't be otherwise qualified to get a new loan; the lender will bear the cost of refinancing. The third says that these mortgage holders will refinance, and the government will guarantee the new loan. The first two proposals screw over lenders, and the last proposal is a government-paid bailout (i.e. paid by everyone else out of taxes or as inflation).

Why is this bad? The problem is that whoever owns the mortgages now is getting totally shafted. They didn't just take a loss when the market value of the mortgage-backed bonds tanked. Now, they're taking a further hit due to the government regulations. Alternatively, if the government pays for a bailout, whoever owns those mortgages makes a windfall profit.

Why is this really bad? Politically-connected insiders who KNEW about this regulation before it was announced MADE A FORTUNE. If they knew that this regulation would drive down bond prices EVEN MORE, they could have made a killing by short-selling mortgage bonds before the regulation was announced. If they knew that the new regulation will drive up bond prices, they can buy in advance.

I'm confused as to whether this regulation is going to DECREASE bond prices or INCREASE bond prices. Some proposals involve forcing lenders to refinance, barring them from adjusting ARMs, or barring them from foreclosing, which DECREASES bond prices. Some proposals involve the government refinancing and backing the new loan, which INCREASES bond prices. Whoever knows which version of the regulation will pass will make a fortune!

It depends on which regulation is passed! If no regulation is passed, mortgage bond prices remain unchanged. If lenders get screwed over, mortgage bond prices will crash further. If the government pays for a bailout, mortgage bond prices will skyrocket. If you know in advance which regulation will pass, you can make a fortune. If no regulation is passed and you know in advance, you could still profit by writing mortgage bond options!

It is the usual story of wealthy politically-connected insiders lining their pockets at the edge of everyone else. It's amazing how government can simultaneously "Help poor mortgage holders!" AND "Profit by screwing over everyone who isn't politically connected." Of course, the latter is the important part.

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