The Financial Bailout: A View of Reality by Al Jacobs

Are you watching as the nation's politicians work to solve the financial meltdown of 2008? Though they all have different opinions on what must be done, they seem to agree on one point: hundreds of billions in taxpayers' dollars must be thrown at the problem.

The popular phrase of the moment is "bailout," with visions of the federal government buying up non-performing mortgage loans from failing financial institutions. At this point it gets confusing as our elected representatives haggle over the details. What shall we pay for these junk loans? How can we prevent Wall Street fat cats from profiting? Who will supervise the spending of all this money? Will the poor homeowners share in the bonanza? How do we make sure the taxpayer isn't ripped off?

Amid the furor of the moment, one important question is ignored: Exactly what will the federal government receive as it shells out its money? As a long-time mortgage investor, I'm familiar with acquiring troubled loans. It's usually a straightforward matter. We'll take an example. John and Mary Jones purchased their home four years ago with no down payment down and a $300,000 mortgage. They've made no payments for the last six months and the bank holding their note is foreclosing. The question becomes, how much will I pay for this loan? What I must know is the current market value of the house-easily determined by comparisons-as well as its probable value a few years hence-this takes a little clairvoyance. Let's presume the property is worth $250,000 today and may possibly drop to $200,000 a few years down the line. On this basis, I'm justified in paying $150,000 for the note, or 50% of its face amount. As its holder, I will try to negotiate a payment schedule with the Joneses. Even at a reduced interest rate, my return will be attractive, and eventual full payoff at some future date will be double my purchase price. At worst, my completing the foreclosure and acquiring the property offers the chance to sell the house for a modest profit. This, in essence, is the heart of the mortgage loan business.

However, this is not the arena in which the bailout is proposed. It's far more complex. The government will not simply acquire the sort of loan I've just described. Let me offer an illustration of the scenario faced. Five hundred loans were packaged together, known as securitized. Some are delinquent, others paying as agreed, and each with its individual terms. Then a ten percent slice of this package got sold off to an investment bank, meaning ownership of a one-tenth interest in each of 500 loans. Finally, this slice was subdivided into two portions, one of which is entitled to receive only the interest payments from the notes, whereas the other receives any principal that is paid. I defy you to figure out what either of these apparitions are worth or what you do with them after you own them.

Nonetheless, the politicos will continue to debate, and harangue, and pose for photo ops, and pretend to know what they are talking about, as they enact legislation that will take the taxpayer to the cleaners. Welcome to our brave new world.

by Al Jacobs, Author of Nobody's Fool: A Skeptic's Guide to Prosperity

www.onthemoneytrail.com