Agora Financial’s Rude Awakening

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Laguna Beach, California

• Got some losing trades on right now? Address complaints to “bail-out
  Paulson,”
• We’ve been wondering…what your thoughts are on the socialization scheme?
• A quick lesson in contract law and plenty more…

Eric Fry, reporting from Laguna Beach, California…

When Treasury Secretary Paulson looks at the nearby chart, he probably tells
himself that he must do something – anything – to help the housing market. We
look at the nearby chart and tell ourselves that the best thing the Treasury
Secretary could do would be nothing at all.

This chart depicts the value of asset-backed commercial paper (ABCP)
outstanding. ABCP volumes are plummeting because most investors are terrified
to lend to an asset-backed entity. (If this seems a little complicated, stick
with us for a moment). “Commercial paper” – or CP - refers to short-term
corporate debt. Specifically, unsecured short-term promissory notes issued by
corporations with maturities that typically range from 30 to 270 days. Asset-
backed CP is that which is collateralized by an asset-backed entity – i.e. an
entity that owns assets like mortgages or credit-card receivables.

Since most institutional investors realize that the prices of asset-backed
securities are tumbling, most investors refuse to provide CP financing to
these entities. And most investors will not resume providing financing to the
AB market until they believe that their collateral is solid and accurately
priced. Private investors have withdrawn a staggering $354 billion of CP
financing from asset-backed entities since August.
Enter Hank Paulson.

By freezing mortgage rates, he seems to imagine that he can convert beastly
mortgage collateral into a thing of beauty. Private investors see it
differently. They see no beauty whatsoever in mortgage-backed securities that
rely on Wall Street’s dubious pricing and Washington’s dubious price-fixing.
In other words, the more the government meddles in the mortgage market, the
less private investors will wish to participate.

The ABCP market will not begin to recover until credibility returns to the
mortgage market. And credibility will not return to the mortgage market until
the Treasury Secretary halts his various rescue campaigns and price-fixing
schemes.

This bail-out business is very bad business.

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The Full, Groundbreaking Report Is Yours Right Here

——————————————–

Just Wondering
By Eric J. Fry

Treasury Secretary Paulson wishes to freeze sub-prime mortgage rates for five
years. Is anyone else wondering what I’m wondering? Which constitutional
amendment empowers the U.S. Treasury Department to retroactively nullify
and/or revise contracts between private parties? And where did Treasury
Secretary Paulson read that he possessed the power to alter the terms of
mortgage contracts between banks and individuals?

Seems like Treasury might be overstepping its bounds just a wee bit.

Even if Paulson’s Treasury did possess the power re-write mortgage contracts
after the fact, why should it? What does this unprecedented meddling
accomplish? The short answer is: Nothing good.

But the meddling does accomplish a wide variety of bad things. It tarnishes
(if not destroys) America’s free-market reputation and undermines all of the
implied guarantees that this reputation conveys – like the guarantee that the
government won’t fix prices in public markets, or change private contracts
after the fact, or in any way expropriate assets or profits that freely
operating markets would otherwise bestow.

Pauslon’s plan replaces these reliable tenets of functioning capitalism with
the expedient caprices of quasi-populism. In other words, Paulson’ plan
establishes a brand new precedent in American capitalism that goes something
like this: The ends justify the means, especially if the ends include
safeguarding Wall Street’s compensation structures.

The specifics of Paulson’s “it’s-not-a-bailout” bailout are as follows:
Homeowners with adjustable rate mortgages (ARMs) originated between Jan. 1,
2005, and July 31, 2007 may be able to qualify for a five-year rate freeze at
their present, lower payment rate. Only borrowers who have been making
payments regularly would qualify for the rescue.

Thus, Paulson’s plan completely ignores the folks who have already lost their
homes or are very likely to do so. “These homeowners will become renters
again,” the Secretary blandly explains. Rather than rescuing homeowners who
are drowning in their debts, Paulson’s plan offers a life raft to borrowers
who are already afloat. The plan helps those who need help the least –
borrowers “with steady incomes and relatively clean payment histories…”

Why the counter-intuitive obsession with healing the healthy? We offer a
cynical guess: healthy borrowers make their payments. Healthy borrowers, as
we pointed out in the December 4, 2007 edition of the Rude Awakening, “are
the ones who currently provide the cash-flow to the mortgage-backed
securities that burden the balance sheets of every Wall Street brokerage firm
and every major financial institution in the land. If the cash-flow
continues, the brokers and banks may avoid paying for their sins of stupidity
and continue paying themselves obscenely large bonuses.”

So why is Paulson’s bailout such a bad idea? Mostly because it rewards
irresponsibility, while simultaneously corrupting the American system of
contract law. Specifically, the plan violates the contracts of investors in
mortgage-backed securities, who may lose money as a result of the rate
freezes.

In order to railroad this overtly non-legal rescue package into the mortgage
market, the creators of the scheme perverted the concept of “industry
standard practice.” (If you don’t understand this term, don’t worry. Neither
did your California editor until his brother, who was a lawyer in a prior
life, explained it to him. Industry standard practice refers to the generally
accepted way of doing something. Everyone bakes a pizza, for example. No one
boils it).

“When securitizers purchase loans,” a recent editorial in the Wall Street
Journal relates, “the Pooling and Servicing Agreements normally assign
[mortgage] servicers a fiduciary duty to maximize cash-flows for the
investors. In some cases, servicers can modify loan terms if this is
consistent with ’standard industry practice.’ [Paulson's] plan establishes a
new ’standard industry practice.’”

The problem is, retroactively freezing teaser rates for a 5-year term is a
maneuver that bears no resemblance to any ’standard industry practice’ that
has ever existed in the American mortgage market. So it’s a very large
stretch for Paulson & Co. to make such an assertion. Not content to simply
pervert this aspect of contract law, the Bush administration also seeks to
reinforce its legally indefensible position by passing laws to immunize all
financial institutions that implement the rate freeze from shareholder
lawsuits.

“Mortgage investors are likely to challenge any re-writing of their
contracts,” writes blogger Juan Carlos Arroyo Calderon at
wallstreetexaminer.com. “If the Supreme Court still honors ’stare decisis’
principles, it will recognize that contract law goes all the way back to
medieval England. If the government can void and rewrite legal contracts
based on pure expediency, we might as well burn the Constitution.”

“Stare decisis,” Wikipedia explains, “is a Latin legal term…to express the
notion that prior court decisions must be recognized as precedents, according
to case law…The term is but an abbreviation of ’stare decisis et non quieta
movere’ — ‘to stand by and adhere to decisions and not disturb what is
settled.’…Under the doctrine of stare decisis a case is important only for
what it decides — for the ‘what,’ not for the ‘why,’ and not for the ‘how.’”

Legal precedent is not optional in a first-world economy. Case law is not a
buffet from which Presidents and Treasury Secretaries may pick and chose
according to the socio-economic whims of the day. The principal of “stare
decisis” is the immutable foundation of any viable economy. If Treasury
wishes to alter the structure of mortgage contracts, it ought to bring a test
case before the Supreme Court. Otherwise, obey the law as written.

Why? Because that’s how financial markets thrive. They thrive by nurturing
reliable, legally defensible agreements between private parties. Not by
concocting perversions of free market practices. They thrive by allowing bad
investments to fail…and good investments to flourish. Paulson’s meddling
accomplishes the exact opposite. It also produces a host of other economic
evils. It: 1) Produces government-sponsored capital losses for the holders of
mortgage-backed securities; 2) Artificially supports home prices; 3) Tightens
available credit for new, good loans but compelling lenders to retain old,
bad loans.

If a government agency, in collusion with the Executive Branch, can simply
dispense with legal precedent, it can also dispense with any other essential
component of the American economic system. Capricious governments do not
instill investor confidence. “If investors all of a sudden feel that a
contract can be changed at the whim of industry participants or at the
jawboning of government,” Joshua Rosner of Graham Fisher & Co. explains to
Bloomberg News, “ultimately that could have the effect of cutting off
capital.”

To put it bluntly, Paulson’s plan is a bad, bad idea.

As long as we are re-setting mortgages, why not re-set other inconvenient
contracts? I’ve got a few January put options that aren’t going my way. So
how about extending my options out to 2013? (Otherwise I might lose some
money. And if I lose a lot of money, I might not make my car payment). Why
impose any limits on ANY contractual agreements? Let’s just consider these
“guidelines.” Or maybe the government should boost interest rates on all
existing bank CDs to 100%, and freeze that rate for five years. Or how about
outlawing foreclosure? Or maybe even outlawing bankruptcy? And while we’re at
it, let’s guarantee that every American make $200,000 per year.

CNBC’s jubilation notwithstanding, Paulson’s bailout plan is so seriously
flawed that it will not likely materialize as drafted. But if it does
materialize and proceed, confidence in America’s free-market economy will
suffer a serious setback. To the extent that Paulson’s plan succeeds,
therefore, America fails.

If the government wishes to bailout bankrupt borrowers, so be it. Bail away.
But do so in a way that respects the sanctity of contract law and preserves
the integrity of the American legal system. Very few countries re-write their
laws after the fact. Those that do tend to lay close to the equator and elect
people named Chavez and Morales.

Is America going the way of her populist South American neighbors? Is she
embracing the familiar policies of economic failure? Is she abandoning the
foundations of her world-leading success?

Just wondering.

—– Why Wall Street Has It All Wrong —–

WARNING! Brace Yourself and Your Wealth for a Whole New “Second Wave” of
Housing Hurt About to CRASH DOWN on Wall Street, the U.S. Economy, and the
American Homeowner…

The “Second Wave” HOUSING TSUNAMI of 2007-2011

Just when you were hoping we were “done” with plunging property prices…
think again… and then BATTEN DOWN THE HATCHES for what history will
remember as the worst property-led recession of the last 76 years!

Wall Street… Main Street… nobody’s money is safe.

However, I can give you three very simple, solid ways to “hedge” your
retirement and property savings against this coming mega-bust…

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——————————

Rude Endnote: Thankfully for your Rude editors, one of our astute readers was
on hand earlier this week to offer some answers to our head-scratchings.

“I don’t think you have yet figured out the Basics of The Fed and “Our”
Government yet,” writes J. Edwards.

“They want everybody to be a ‘renter’ and the houses to be Government
projects. It’s called Socialism.

“We have more socialism in the USA today that Stalin-Lenin ever
accomplished,” Edwards continues. “Socialism is OK for populations who have
certain mind sets where no one aspires to affluence or to improve the culture
by engineering and science. But for us, it is tyranny.

“I don’t want to pay for the profligate lifestyle of others.”

And so, Rude wonders, why should you have to?

Send your thoughts to the address below.

Cheers,

Joel Bowman
Rude Awakening