Archive for August, 2007

Glad Rags of Populism

Friday, August 24th, 2007

In the subprime meltdown, certain thought leaders are serving financial industry special interests while draping themselves in populist raiment.

Schumer and Dodd propose loosening regulation to let Fannie & Freddie buy subprime and jumbo loans. They claim to protect the working man. But who really benefits from a subprime rescue?

No benefit to subprime homeowners. They have little or no equity now — in many cases, they had none to begin with — and thus nothing to lose by defaulting.

No benefit to banks — they sold the bad loans long ago.

No, the beneficiaries of a bailout would be institutional investors holding bad mortgage-backed securities (MBS). Where are these unfortunates located? New York (investment banks and hedge funds) and Connecticut (insurance & pension funds).

Now let’s see, who are Schumer’s and Dodd’s constituencies? Why, New York and Connecticut. What a striking coincidence.

PIMCO chairman Bill Gross also appears possibly biased by self-interest. He recently suggested in his monthly letter that the federal government directly bail out defaulting homeowners. He then republished the proposal in the Washington Post.

Longtime readers of Bill Gross will remember his April 2003 issue, in which he details some of PIMCO’s income strategies. These included:

  • Buying mortgages while shorting an appropriate index
  • Selling out-of-the-money put and call options on Treasury bond rate swaps and futures.

The first strategy would tend to be killed by a wave of mortgage defaults (and rescued by a federal bailout). The second strategy would tend to be killed by a sudden spike in volatility of Treasury bond rates, as might occur in a monetary policy rescue — leaving a fiscal rescue as the only way to preserve the second strategy.

Again, what a coincidence that Mr. Gross appears to propose exactly the solution that would appear to most benefit himself.