EXPLAINING OBAMA'S PLAN

If you’re wondering why President Obama has had to introduce a $75 billion plan to encourage loan holders to renegotiate with distressed homeowners here’s a primer.

We know that financial institutions got themselves into trouble by making incredibly stupid loans. If you had a pulse and could fog a mirror you got a home loan. Financial institutions have suddenly got religion, and are now reluctant to make new loans and are opposed to readjusting existing home loans. They contend that they don’t have any money. What they don’t have is a moral compass, or a collective conscience. The reality is financial institutions aren’t renegotiating home loans because it’s not in their financial interest to do so. Here’s why.

• Home loans were bundled together and sold to financial institutions.

• Bundled loans sold as a package – with a total value of, say, $100 million – created new income streams (from the loan payments you and I make).

• Financial insitutions know that if they renegotiate loans the value of each group of bundled loans could drop between 20-40% (or more).

• Financial institutions would rather keep a set of loans valued at $100 million rather than $60-80 million – even if it means burning down the house.

So, this is what we have ...

Financial institutions, who currently have their hand out, and are living off of the American taxpayer, don’t want the value of their bundled loan packages to go down. They want their $100 million, as it were. They are betting that homeowners and other debtors will be held to their contracts and/or that the American taxpayer will end up making up the difference through a bailout program (made possible by Section 132 of TARP).

Unless we nationalize financial institutions and force renegotiations, or offer incentives through legislation, they will not renegotiate with homeowners who are distressed.

This explains why President Obama has had to introduce a new program to induce financial institutions to renegotiate with home owners who are underwater, or have seen their income situation deteriorate. Unless they are nationalized, forced by legislation, or induced with financial incentives the financial institutions will not renegotiate (as FDIC chair, Sheila Bair, found out). If this situation continues we will move from a situation where 10 million homes are underwater today to having more than 15 million underwater within one year. People will continue to walk away from homes, and housing prices will collapse even further. It’s that simple.

This is really the first step of a broader program that is needed. Some may call it incrementalism. I call it a step forward – as long as President Obama does something about reducing expectations on the bundled loan payouts (called Collateralized Debt Obligations).

If President Obama’s program doesn’t do the trick, I say we nationalize the failed institutions and force home loan settlements. The financial industry is derisively calling this option a "cramdown." I like it already.

- Mark