Sunday, December 09, 2007

Do I smell a class action?

Risk and reward go hand in hand.
That is the one lesson that anyone enrolled in Mr. O'Meara's Security Analysis class will never forget. If you desire a larger return on your investment, you must make a riskier investment. Likewise, if you desire a larger home than you can afford, you must take a riskier mortgage. But federal officials have taken action to rewrite this equation; reducing the risk for adjustable rate mortgage holders by reducing the reward to the lenders for those mortgage loans.

The Bush administration reached an agreement with the mortgage industry on Wednesday on a plan to freeze interest rates for up to five years for a portion of the two million homeowners who bought houses in the last few years with subprime loans.

The plan, hammered out after weeks of talks among Treasury Department officials, mortgage lenders and Wall Street firms, would allow distressed borrowers who are current on their payments to keep their low introductory rates and escape an increase of 30 percent or more in their monthly payments when the rates expire.
So reports the NY Times. Captain Morrison opines.

Thus endeth the free market. A free market doesn't just involve consumers, but also producers, who need to earn a competitive profit in order to stay viable and continue to produce. Lenders sell ARMs with an eye to long-term profits by offering very thin margins for themselves on the front end. If they cannot adjust the rates of these ARMs on schedule when the price of money rises, then they lose the profit on which they have planned.

What does that do to the market? The producers -- lenders, in this case -- have to either raise prices or restrict production. In this market, it means that credit tightens and people who may have been able to get home loans will get rejected instead. ARMs will almost certainly decrease, if not disappear altogether. Some may find that appealing -- but it will exclude many potential homebuyers from entering the market. That will increase the downward pressure on home valuations, already a major problem in this economy.

I might be wrong, but it was my understanding that Wall Street doesn't own these mortgages, they sell these mortgages. Sell them to investors like you and me.

I own a variety of mortgage securities by way of mutual funds, and I expect that my portfolio includes some of these subprime loans. I do not agree that the agreed-upon interest rates in these mortgage contracts should be ignored and forgiven for the next 5 years. The highly-paid professionals that I pay to manage these investments were the one's who made that decision.

By agreeing to freeze interest rates on my mortgage loan investments, my investment managers have violated their fiduciary duty to their investors. I will not be the only one to notice this. There are also legal experts on Wall Street who make a living on the misdeeds of investment managers.

1 comment:

Dad29 said... won't be the first time that Uncle Sam has created a moral hazard--nor the last.

Nukers should be aware of that, no?