| It was 1976 when I became a fan of Barron's. The | | | | same loan is made to a AAA borrower and the |
| Dow Jones Industrials were below 1,000. Mr. | | | | borrower's credit score falls, the market price of the |
| Ableson's wit made me laugh as he skewered the | | | | loan falls to reflect that decline in credit quality. If the |
| valuations that would justify a Dow above 1,000. In | | | | value of the asset that secures the loan falls, so |
| 1977, the 30-year treasury was trading at a yield | | | | does the market price of the loan. As house prices |
| around 7.75% on its way to just above 15% only | | | | fall, the underlying security of a mortgage falls. As |
| four years later | | | | people lose their employment, their ability to pay their |
| I will continue reading this august journal. However, | | | | existing mortgages evaporates. |
| when I read the front page editorial this weekend, I | | | | Until housing prices stop falling, and there is a floor on |
| was deeply saddened. Barron's magazine holds a | | | | housing values, the economy will continue to decline |
| special place among financial publications in the United | | | | in a deflationary spiral. Household wealth will continue |
| States. The depth and breadth of its financial | | | | to be destroyed; fear and desperation will rule the |
| reporting is rarely matched. It has access to the best | | | | day. The government must enact a national |
| and brightest minds in business and investing giving | | | | moratorium on foreclosures. Instead of a bank |
| Barron's the ability to inform its readers, industry | | | | holiday, call it a foreclosure holiday: No more |
| leaders and government, in a unique and thoughtful | | | | foreclosures for at least 24 months. |
| way. This weekend, Barron's lost an opportunity to | | | | Barron's is right to identify mortgage principal |
| help its readers, our leaders, and the government, | | | | modifications as a key step in healing our national |
| really understand the severity and complexity of the | | | | economic wounds. But the modifications are closer to |
| current crisis. | | | | 50% of face value of the first mortgage and 100% |
| The Barron's Plan presents some bold and seemingly | | | | of the second mortgage. If the problem were only |
| radical ideas. It proposes to take $200 billion of the | | | | with the banks, this might be relatively easy to do. |
| TARP money and reset the principal balances of | | | | However, the problem lies in the structure of the |
| approximately $850 billion of sub prime mortgages by | | | | residential mortgage market and mortgage |
| an estimate of 25%. I applaud the ideas, but I think | | | | securitizations. Mr. Laing's article clearly articulates this |
| they fall short of addressing and solving the difficult | | | | problem is in the "Shadow Banking System" not just |
| problems we face. | | | | at the banks. As most residential mortgage |
| The Barron's Plan approaches the problem from the | | | | securitizations are structured, there is no legal way to |
| top down. Fix the banks; make them modify | | | | fix troubled mortgages. The pool servicer does not |
| mortgages; get cash flow moving; get lending | | | | have clear legal authority; the pool trustee does not |
| restarted. The problem is that this is the old solution. | | | | have clear legal authority; the investors do not have |
| It won't work; it can't work. The banks are no longer | | | | the clear legal authority; and no one can act, |
| the financial system, but are rather a part of the | | | | unilaterally, without significant risk of legal action. |
| financial system. And they are an increasingly smaller | | | | Only the federal government can break this log jam, |
| part of the financial system. Like General Motors, the | | | | and Americans must demand that their government |
| banks do not understand that the world changed | | | | act. Most mortgage backed securitizations, holding |
| while they were at the party. Now they have to deal | | | | pools of mortgages on U.S. property, have U.S. |
| with a whole array of institutions that are not banks, | | | | domiciled trustees. This means they are subject to |
| but lend; that are not investors, but invest. | | | | control by the U.S. government. I strongly suggest |
| Increasingly these new entities are the financial | | | | that the government mandate by law that the |
| system, and they are becoming a larger part of the | | | | trustees of the securitized mortgage pools have the |
| system every day. They have other attributes | | | | authority to modify, change and amend both principal |
| compared to traditional banks; they are global, virtual | | | | amounts and interest charges on any loans in any of |
| and mostly unregulated. Let me refer back to an | | | | the pools. Further, the trustees must have the clear |
| earlier issue of the publication. | | | | legal authority to sell, trade, and/or exchange any |
| First, let's look at the February 9th issue of Barron's | | | | mortgage held in the pool. The federal government |
| magazine. There are two articles in particular that | | | | must then redraft the terms and conditions of all |
| warrant review. The first is by Senior Editor Jonathan | | | | securitizations giving the trustee the power and |
| R. Laing, titled "Advice to Geithner: Don't Hold Back." | | | | authority to take any and all actions with respect to |
| Mr. Laing is absolutely correct when he says, | | | | any and all assets in the pool. |
| "Likewise, government purchases of banks loans | | | | In addition, all tranches of any and all securitizations |
| won't send nearly as powerful a signal as buying, say, | | | | of U.S. residential mortgages must have a CUSIP |
| asset backed securitizations comprised of hundreds | | | | number. Market quotes, both bid and ask, must be |
| of loans diversified by issuer and geographical locale." | | | | made available through major services like Dow Jones |
| The second article I wish to draw attention to is | | | | in lot sizes of less than $20,000 to retail as well as |
| Senior Editor Sandra Ward's interview with Ray Dailo, | | | | wholesale buyers. Investors and homeowners should |
| chief investment officer, Bridgewater Associates, | | | | be able to see what is outstanding on the pool that |
| titled. "Recession? No, It's a D-process, and It Will Be | | | | holds their mortgages and bid on any of those |
| Long." In this interview, Ms. Ward asks two very | | | | securities. This will help provide liquidity to a market |
| important questions. "So where do things stand in the | | | | that is locked up, where the disparity between the |
| process of restructuring?" and "Is a restructuring of | | | | bid and ask is extreme. If the market value of these |
| the banks a starting point?" | | | | securities is less than homeowners' estimates of the |
| The Barron's Plan correctly identifies mortgage | | | | value of their homes, then homeowners have a |
| principal modifications as a critical first step, but it | | | | strong incentive to buy pieces of the pool and |
| does not correctly identify, as does Mr. Laing, the | | | | exchange face value of the certificates for face |
| entities that need to be effecting these | | | | value of their mortgage. And thus will liquidity be |
| modifications, the vast number of residential | | | | provided to the market. |
| mortgage securitizations. Where the plan speaks to | | | | Now let me comment on the economy and financial |
| the need for government action, it does not address, | | | | system that we do not exclusively control. We are |
| as does Mr. Dailo, the massive global deleveraging and | | | | past the era of "too big to fail" and are now in the |
| corresponding asset devaluation that is pounding | | | | era of "too big to save." The interview with Mr. Dailo |
| domestic and global markets and credit. Perhaps a | | | | of Bridgewater Associates makes the global problem |
| panel discussion with Secretary Geithner, Mr. Dailo, | | | | quite clear-deleveraging, devaluation of assets and |
| and Mr. Gross of Pimco, as well as some of the | | | | global deflation. The current global financial system is |
| Round Table regulars, might be illuminating. | | | | like a large housing development facing a wild fire |
| The Barron's Plan comments on the need to get the | | | | racing up a canyon. In each country, its central bank |
| economy "back on track" and the "financial system | | | | and regulators are like firemen assigned to specific |
| fixed." The plan takes a top down approach with a | | | | houses under their jurisdiction. Rather than collectively |
| focus on existing banking institutions. Barron's does | | | | fighting the larger fire strategically, they focus on |
| not address which economy needs to get back on | | | | their individual houses, seemingly oblivious to the |
| track? Are it referring to the economy of General | | | | raging destruction about to engulf them. |
| Motors (GM) and the mid 20th century? Or is Barron's | | | | The interconnectedness of global financial systems |
| talking about the economy of companies like GT | | | | makes it necessary for global regulation. At the same |
| Solar International, Inc., (SOLR) and those of the | | | | time everyone must understand that locking down |
| early 21st century? This is a question about where | | | | financial markets and innovation is deeply damaging to |
| Barron's is focused. If Barron's is looking forward, | | | | everyone, rich and poor alike. Commerce, both local |
| then they need to be focused on the small and | | | | and global, depends on well functioning financial |
| emerging companies and entrepreneurs. These | | | | markets, fund flows, trade financing, lending, and |
| individuals and companies do not get bailouts. They | | | | credit. As all humans have, by their nature, "the |
| cannot get credit and necessary financing to grow. | | | | propensity to truck, barter and exchange one thing |
| They cannot come to Washington and ask for help. | | | | for another," so must all people have a well |
| Consequently, when the plan refers to fixing the | | | | functioning financial system. But how do we get |
| financial system, which system needs fixing? Is it the | | | | there? |
| system of large global financial institutions and the | | | | Our global financial system needs to work within a |
| large global clients they serve? Or is it the system of | | | | few guiding principals: transparency, free and open |
| small local banks, finance companies, venture | | | | access, honest and fair dealing, and strong and |
| investors, and individuals? Perhaps, a check the data | | | | effective global regulation. The market participants |
| on which of these groups create the most new | | | | must have certainty that the playing field is level in all |
| business and jobs, might be of value. | | | | respects. No one likes to play in a rigged casino, |
| Part of the difficulty with "fixing the financial system" | | | | unless it is with someone else's money. The financial |
| is that there may be than one. There is a financial | | | | press has a responsibility to help shape the |
| system and economy that is within the United States | | | | developing dialogue and debate about what the global |
| and governed exclusively by state and federal | | | | financial system of the 21st century will look like. |
| governments of the United States. There is another | | | | Barron's magazine should lead that debate. |
| economy and financial system that is both within and | | | | Lastly, while this shock to our economic system has |
| without the United States, which is governed in part | | | | been generated by financial excess, the next shock |
| by the U.S. government, but also by other sovereign | | | | may come from elsewhere. Could Western Europe |
| entities. There is a financial system of regulated | | | | save Iceland or the United Kingdom? How would |
| entities and a financial system of mostly un-regulated | | | | commerce, industry and finance react to a pandemic, |
| entities. We American citizens and our government | | | | a devastating drought in China or India, or some |
| can fix the system and economy we regulate and | | | | other "exogenous event?" |
| control. We cannot fix the economy and financial | | | | The Barron's Plan takes a needed step forward. It |
| system we do not regulate and control. | | | | does not stand up and remind everyone; citizens, |
| Addressing what we do control, let's first be clear | | | | banks, and government, that we really know next to |
| about the nature of mortgages and the related | | | | nothing about identifying and managing risk. And as a |
| structural problems. Mortgage debt is a loan secured | | | | long time reader of Barron's magazine, I think it is fair |
| by title to an underlying asset. If a loan of $100,000 | | | | to say that Barron's lesson to its readers over the |
| is made at 5% interest and the market rate goes to | | | | years is, "If you do not understand the risk, you |
| 10%, the loan is worth, in the market, $50,000. If the | | | | cannot understand the return. |