The rally on Wall Street yesterday was the largest one-day jump in 5 years. Was the rally based on healthy economic news? No. Was the major increases based on a housing market turning around? No. The rally was based on the notion that the Fed was going to start exchanging Treasurys for mortgage-backed securities. So what exactly occurred yesterday? In essence, the Fed has decided to become Wall Street’s pawnshop:

“The program will lend up to $200 billion of Treasurys to primary dealers, a group of 20 big investment firms, for a 28-day term. The firms can put up as collateral mortgage-backed securities issued by Fannie Mae and Freddie Mac, which generally are seen as safe because of an implicit government guarantee.

But in an unusual move, AAA-rated mortgage securities issued by banks will also be accepted. Many investors have shied away from these mortgage-backed securities because they fear defaults in the underlying assets will erode the value.”

California is still facing massive budget short falls as are many other states. Does nothing to address the now ever increasing job losses. I love how many folks were crowing about lifting caps not being such a big deal. This is exactly why it is a big deal. The lifting caps was to allow as many loans to be refinanced that were actually garbage, slap a AAA rating on them or funnel them into the GSEs, and then hand them off to the Fed for something of actual value. The reason there is no market for this stuff is because many of these loans aren’t worth the paper they are printed on. The slippery slope argument comes to mind here. It should now be utterly apparent why there was such a persistent fight to keep the rating agencies from downgrading anything because now, all that needs to be done by these investment firms is to roll up to the Fed and exchange toxic mortgage sludge for something of actual value. Take a wild guess what this is going to do to our dollar and the overall economy? This is a flat out bailout principally geared at Fannie Mae and Freddie Mac. The mortgage market in the US is huge. It is roughly $11.2 trillion in size and Fannie Mae and Freddie Mac hold $5.61 trillion of this amount. What’s worse, is that Fannie Mae itself has approximately $133 billion in subprime or subprime like loans on its books. Interesting how this number fits nicely with the $200 billion pawnshop plan. I will now remove my tinfoil hat.

*Hat designed to ward off future bailouts and also can be used for Jiffy Popcorn.

So let us now look at some potential examples of what kind of mortgages will be funneled into this glorious pawnshop now known as the Federal Reserve. Today we salute you Artesia with our Real Homes of Genius Award.

Two for the Price of One

What if I told you that you would be able to purchase two homes for the price of one if you were to wait for slightly over a year? Sounds too good to be true? Maybe this rings like a real estate late night infomercial and you’re expecting someone in a Hawaiian shirt to tell you how you will never have to work another day in your life and have a nice tan too. Who said you couldn’t have everything in life? The above 836 square foot home is exactly this kind of deal. This 2 bedroom 1 bath home located in Artesia is now selling for an incredible $180,000. Now where does the deal come in you may be asking? Well let us look at the sales history on this place:

Sale History

12/22/2006: $363,000

09/11/2006: $260,000

06/26/1970: $2,000

So in a little over one year, the price has been slashed in half. Now, you can buy two places like this for the price of one. Of course this place is a short sale but what ever happened to that note that accompanied the sale for $363,000? Keep in mind that the original sale, given the price falls into the conforming loan limit range even before the caps being raised, may well have placed this home into a government backed loan. Now, the market is setting the price so the $180,000 price is now the true value of the home assuming it sells at that price. Yet that original note doesn’t vanish into thin air. Now, many mortgage holders that own these mortgages, can stop by their local government sponsored pawnshop and exchange the mortgage-backed security for nice and exchangeable US Treasurys. Isn’t that grand? Yes, the market on the street is telling us that the value of the home is only $180,000 but I wonder what the good people at the Fed will be handing out to the investment firms? Here is another issue that isn’t really being discussed. Are they going to pay the face value of the note? Let us assume this was a 5 percent down purchase, will the government hand over to the investment firms $344,850 worth of Treasurys?

Clearly there are many nuances that simply need to be worked out. In addition, the firms need to pay back the money after the 28 days are over. Now riddle me this, if they can only sell a place like this for $180,000 and owe the government back $344,850 plus interest accrued, where in the world are they going to come up with the additional $164,850? These mortgage-backed securities are bundled but that doesn’t mean that they are disconnected from the underlying asset. After all, the entire reason we are in this mess is because the underlying asset was over inflated. Therefore, it is important to understand how the Fed is going to value these MBS exchanges. Clearly many of these firms are not going to be able to pay back their exchange because the reality is, many of the homes will not come remotely close to yielding the initial face value of the mortgage unless homes appreciate by 20 percent this year. My guess is the Fed will continue to roll over payment and give forbearance to many of these investment firms. These are the same firms that are beating current owners/servicers over the head to pay their mortgage. Is that price disconnect going to improve in the next few months? Of course not. All this does is pushes the day of reckoning a day further and ultimately does not help 95 percent of the population.

The program will start on March 27 so we’ll see how it goes. Nothing has happened yet. But this has the same chance of helping the overall economy just as much as all the other failed bailout, whoops, I mean liquidity measures that have occurred over the past year. Until our leaders have the courage to let many of these firms go under for flat out unscrupulous lending practices and allow the market to adjust, we are going to continue to see things like this. Contact your Congress person and let your voice be heard. Nothing wrong with some of these proposals including the OTS negative equity certificates or allowing judges to do cram-downs. But these are things that will hurt lenders and the few power brokers on Wall Street so of course they are off the table and didn’t garner any traction. But what isn’t off the table is making the Fed the new pawn shop of America.

Today we Salute you Artesia with our Real Homes of Genius Award.

Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information