Acronym Deja Vu

I just want to make sure I understand today’s European bailout rumor/plan correctly…

First, the European Financial Stability Fund (EFSF) will construct a Special Purpose Vehicle (SPV)

Next, all the European sovereigns with pre-default debt will place their toxic paper into the SPV.

Then, the SPV will issue bonds back to the same pre-default sovereign nations.  These bonds will be rated as investment grade.

Finally, the pre-default sovereigns (PIIGS) will use their freshly minted investment grade bonds to borrow at favorable rates from the European Central Bank (ECB), to recapitalize their banks.

Maybe I’m having deja vu all over again (with all appropriate props to Yogi Berra).

Only the last time, instead of EFSF, SPV, PIGGS, and ECB the acronyms were MBS, CDO, CMO, and TARP.  The track record of blending together massive volumes of toxic debt, slicing and dicing it, and having investment grade debt come out the other side is a little less than stellar.

But, hey.  The rumor/plan was worth a couple percentage points on the major stock market averages.  A few more acronyms and we’re likely to have a bull market on our hands!

 

Thought about it all weekend… still couldn’t figure it out

Last Friday, the Federal Housing Finance Agency (FHFA) announced a lawsuit against 17 major banks alleging misrepresentations involving of mortgage-backed securities sold to Fannie Mae and Freddie Mac.  Both Fannie and Freddie are presently under the conservatorship of FHFA after they went belly-up.  There’s nothing unusual about a conservator trying to recapture losses due to misrepresentation, but this particular case is awfully confusing.

So confusing, in fact, that I tried to flowchart it this weekend and couldn’t figure it out.  Since I’m not particularly the finest drafter of flowcharts nor an expert on the economics of banking, I thought I’d share my conclusions here and maybe a reader could help me understand.

The facts as I read them are as follows:

  • Freddie Mac and Fannie Mae were infused with $200 billion in taxpayer money to keep them from collapsing under the weight of bad mortgages prior to them being put under the control of FHFA.
  • The banks being sued were infused with $245 billion in taxpayer money via the TARP program to keep them collapsing under the weight of bad mortgages.
  • In exchange for bailing out Fannie and Freddie, the U.S. Treasury received $2 billion in preferred shares of the GSE’s, paying a 10% dividend.
  • The troubled Residential Mortgage Backed Securities involved in this lawsuit are worth about $55 billion, plus any punitive damages.

So…  if I understand the facts…

Taxpayers put a total of $445 billion into a combination of the prosecutor and the defendant.  If the prosecutor should prevail, $55 billion plus damages of taxpayer money would be transferred from the rescued banks to the rescued GSE’s.  The resulting shuffle of already-spent taxpayer capital would result in an estimated 30, 000 banking jobs lost, while the political capital of  “sticking it to the banks” would be invaluable.

The net economic effect of the lawsuit?  Zero.  The number of underwater mortgages resolved as a result of the lawsuit?  Zero.  The taxpayer benefit of the lawsuit?  Zero.

Am I missing something here?

It’s like living in a metaphorical version of a 1912 high-class cruise.  We’ve spent billions on this lovely ship.  It hits an obstacle and splits in half in the North Atlantic.  The deck chairs (or billions of dollars) are shuffled about and the band plays on (the lawsuit is jawboned) to keep the passengers happy.  Rearranging the chairs and hearing the pretty music seemed nice for a while…

For a while.

But ultimately, the passengers come to realize that shuffling chairs under the dulcet tones of the orchestra does nothing to keep the ship from sinking.

You can perform superficial acts to keep fear at bay for a while, but ultimately reality sets in.

When you’re finally dunked in the briny deep, the water is very, very cold.