Friday, 19 September 2008 05:00

My initial analytical take on what we know so far of the "Man's" Master Plan

Ban on short-selling

US: The Securities and Exchange Commission on Friday issued an emergency order temporarily banning short selling in the shares of 799 financial institutions until midnight on October 2, 2008. The SEC said it may extend the order if it's necessary to protect investors, but it won't last more than 30 days. In a pre-trading market GS and MS have gained 10%.

The U.S. Securities and Exchange Commission may require hedge funds to disclose their short-sale positions and plans to subpoena the funds' communication records. The SEC would hedge funds and investors managing more than $100 mn to publicly report their daily short positions. SEC has also made it a securities fraud when sellers deceive brokers about delivering shares to buyers. The SEC would also impose penalties on brokers if their clients haven't delivered shares to buyers within three days of a short sale. The SEC also approved a rule drafted in March 2008 that it would amount to be a fraud for investors to lie to their brokers about locating shares to be sold short. Currently, brokers rely on their customers' assurance that they had located shares that could be used to cover a sale.

UK: Britain's Financial Services Authority has imposed temporary ban on investors from taking new short positions in financial stocks from midnight on Thursday, September 18. The ban has been imposed until January but would be reviewed each month.

Likely impact on the markets:

UK: UK banking stocks made double-digit gains on September 19 with the ban on short-sales coming into effect. The FTSE 100 was 332 points higher at 5,212, a rally of 6.1 per cent at the start of the first session.

US: The ban would lead to rally in the near-term, i.e. as long as the ban is in effect. However, once the ban is lifted, whether the markets would remain stable or plunge will depend on the success of the current government plans to stabilize markets and avert further deepening of the crisis. We expect the ban if imposed would most likely continue till the Congress elections, lest the volatility resulting from lifting of the ban may impact the markets and the economy thereby impacting citizens' sentiments.

Steps being considered by US government and Fed Reserve to resolve the housing and credit crisis

1. Create an entity to buy distressed assets from the market - the SAFE plan

U.S. Treasury Secretary Henry Paulson is making proposals to create an entity to deal with the clogging the financial system. The idea has been compared to the Resolution Trust Corp formed in 1989 and the Home Owners Loan Corporation of the 1930s.

Saving America's Family Equity (SAFE): SAFE loan plan is modeled after the successful Home Owners' Loan Corporation (HOLC) of the 1930s.

The original HOLC program


  • The HOLC was established in 1933 to help distressed families avert foreclosures by replacing old mortgages (that were in or near default) with new mortgages that homeowners could afford.


  • HOLC bought old mortgages from banks (traded for safe government bonds) and then issued new loans to homeowners.


  • The HOLC financed itself by borrowing from capital markets and the Treasury.

Size and scale:

  • Within two years, the HOLC received about 1.9 mn applications and granted about 1.0 mn new mortgages. (Nearly one of every five mortgages was owned by HOLC). The corresponding mortgage figure today would be almost 2.5 mn.
  • Its total lending over its lifetime amounted to $3.5 bn -5 % of the gross domestic product at the time. (The corresponding figure today would be about $750 bn).
  • Nearly 20% of the HOLC's borrowers defaulted. So the corporation acquired ownership of about 200,000 houses which were sold by 1944.

Remodeled HOLC - SAFE plan

The SAFE plan would use existing government agencies and government-sponsored housing institutions to purchase pools of loans at current value and refinance those into fully amortizing, fixed-rate loans based on the current value of the property. (Most of the refinanced loans would take the form of new fixed-rate 30-year mortgages underwritten to 80% of current home value).

Under the SAFE loan plan, Treasury and the Federal Reserve would run auctions, in which Federal Housing Administration originators would purchase mortgages from current investors at discounts. Investors would take a hit through haircut and yield in exchange liquidity and certainty. The Federal Housing Administration will work with responsible originators to restructure the loans they acquire to stem defaults, foreclosures, and liquidations. SAFE loans would be pooled into securities and sold to private investors.

Structural problems which may concern implementation of SAFE plan

In the 1930s, banks knew all of their customers. Today, most mortgages are securitized and sold to buyers who do not know the original borrowers

Proposed design changes from HOLC


  • The original HOLC bought mortgages outright and then issued new loans to homeowners.
  • But Barney Frank, the Massachusetts Democrat, and Senator Christopher J. Dodd, Democrat of Connecticut, the chairmen of the two banking committees of Congress, are now cooperating on a different design.
  • Their approach would be to use FHA to guarantee new mortgages (issued say, by banks) instead of buying up old ones.
  • The effects although would be similar: Old mortgages would be replaced by new, affordable mortgages and the government would assume the risk of default. However under the Frank-Dodd proposal, the federal government would be a big insurer rather than a big bank.


  • In the new plan existing mortgages would be bought below face value, forcing investors to "take a haircut." But homeowners who get new mortgages to replace their old ones should also be made to pay for the privilege. Otherwise F.H.A. would be flooded with applicants.

Legal Hurdles

  • FHA would have to deal with legal complexities that were absent in HLOC. Back then, banks held mortgages in their loan portfolios. But most mortgages currently are bundled into pools and then sold to investors all over the world.
  • To buy selected mortgages out of these pools, FHA must clear a legal hurdle. The Congress must pass legislation shielding servicers from legal liability.

Setting Prices

  • Conceptually, haircuts should reflect current market values, which are well below face values. But there is a problem of price discovery. With the resale market for mortgages virtually shut down, there are hardly any market prices. The draft legislation is vague on this point.

Lack of market participants

  • The FHA would use government guarantees to induce private businesses to buy these mortgages.


  • Mr. Frank and Mr. Dodd have proposed that FHA mortgages be packaged, securitized and sold back into the market as soon as conditions permit.
  • Once normal conditions were restored to credit markets, the SAFE plan would automatically cease operation.

Eligibility and Scale

  • Mr. Frank and Mr. Dodd are thinking about one to two million mortgages, although there is general feeling that there are a larger number of mortgages.
  • Only loans on owner-occupied homes would be eligible for restructuring. Speculators and second homes would be excluded.
  • Based on current estimates considering refinancing one to two million mortgages with average mortgage balance of $200,000, the new HOLC might need to borrow and lend as much as $200 bn to $400 bn.

Road map to financial stability

  • The plan would help to restore liquidity in the marketplace and help markets function more smoothly. Investors' and creditors' confidence will most likely be restored. This new mechanism can assist the FDIC to resolve sick institutions. Instances such fallout of Lehman Brothers and Bear Sterns may be averted going forward.
  • By warehousing the troubled paper for a longer period than the Fed's discount window would typically do, it would allow for a more orderly liquidation and the chance to recover a significant portion of its value, except for the fact that much of it was leveraged on top of a massive bubble - meaning there is a slim chance price levels will return to that of par.
  • By giving the agency the ability to manage mortgages with flexibility to keep people in their homes, it should lessen the number of foreclosures. This, in turn, would help moderate the decline in real estate values and the deterioration of neighborhoods, thus supporting house prices
  • Since the earlier plan to bail financial sector in 1933 and 1989 were successful, there could be high probability that the plan if implemented could help restore the financial distress.


  • Political will: Currently the US Treasury and Federal Reserve are not working on such a plan, but are only looking closely at how previous interventions were used to redress systemic market crises. However according to Senate Majority Leader Harry Reid the U.S. Congress is unlikely to pass new legislation to overhaul financial regulations this year. He said' It is a multitrillion dollar issue that's facing America and we can't do it on some timeline that is unrealistic.'' Any such plan would require legislation which may not occur before the US presidential elections.

Paid subscribers can download the rest of this document here: pdf Mortgage Bailout Initial Summary (664.39 kB 2008-09-19 13:27:25)

Last modified on Friday, 19 September 2008 05:00