By Tom Kaufman and Christian Hudson
Originally published in the Santa Cruz Sentinel: 02/28/08
Congress is in a special position to make some news Wednesday and Thursday as Federal Reserve Chairman Ben Bernanke makes a return trip to Capitol Hill on the heels of new housing data showing foreclosures up 8% from last month and 57% from a year ago according to a RealtyTrac study - which is a foreclosure marketer.
There are lots of plans being circulated around Washington, some even sound like government backed bailouts for homeowners. That’s why Wednesday and Thursday really matter. It is a chance to hear Congress essentially ask the Fed, “well, what do YOU think should be done?”
If you caught our Sunday column, you know that we’re worried about something that is even bigger in sheer size than the subprime mortgage mess - namely credit default swaps . How big? U.S. banks are on the hook for multiple times more money than they are for subprime mortgages. They basically work like insurance where Wall Street covers each other should someone not pay up on a loan. The complication? Well, unlike insurance they aren’t required to report all their deals, so it is hard for people to know if the person that is covering them is really going to come through. So if we’ve wiped out on the mortgage wave, what happens on a wave multiple times bigger?
The Fed is legendarily obtuse in answering questions. But, unlike his predecessor, Mr. Bernanke has shown a willingness to let more light in, so we say let there be light! Fiat lux, Mr. Bernanke. Here’s what we’d like the Chairman to answer:
1) What does it mean in terms of risk to the market that U.S. banks have many times more the amount of exposure in credit default swaps as they do to subprime exposure?
2) Some of the competing subprime solutions suggest a government backed bailout for those homes now worth less than their mortgage - what are the risks of doing that and doesn’t that stiff those penny wise savers who waited to buy their first home once the market cooled off?
3) Most notably last time you were on the Hill - a little over a week ago - you did NOT take the opportunity to say there's a light at the end of the tunnel - that seems to imply that you haven't identified where that proverbial light is yet - is that fair?
4) One analyst in Fortune Magazine, Pimco’s Bill Gross, says there’s a liquidity crisis problem of the unregulated banking system. Is that right? Can you keep the financial derivatives excesses in check without more regulation?
5) Here's a scenario for you: Subprime mortgage debt causes defaults for institutions who call in their private hedged bets in the form of credit default swaps only to find them unable to pay up. This causes further indigestion and insecurity in the market place where institutional money is not willing to buy bonds, thus everyone from the swashbuckling real estate tycoon to the run of the mill school project can't raise capital. No capital means no construction, no construction means no jobs for an active workforce. This makes banks even more reluctant to hand out mortgages. The result? Continued decay and atrophy in the number of people who are in a position to buy homes causing home prices further fall pushing more homeowners into the category of shouldering a mortgage greater than the price of their home. Does that keep you awake at night?
Tom Kaufman is the Capital Markets Committee Chairman for the American College of Real Estate Lawyers and is a partner at Hunton and Williams LLP in Washington, D.C.
Christian Hudson is a former CNN Senior Producer now practicing finance and real estate law at Hunton and Williams LLP in Washington, D.C.
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