The Obama Mortgage Plan

I understand the desire to help those homeowners who have problems with their mortgages.

But I also believe there is a need to get mortgage-related assets off the books of the banks and into the hands of less risk-averse investors. This must be the biggest potentially mutually beneficial exchange since...well, the Resolution Trust Corporation.

The new mortgage plan has a mixed set of consequences, some unintended. I fear that it throws a lot more uncertainty into the valuation process. It will also take some of the more clearly profitable mortgages out of the pools -- which could be a plus. On the first point, uncertainty, it would seem to make the valuation of mortgages and mortgage backed securities even more difficult. Who is now going to be in default? How do we assess likely default rates if the feds are encouraging the lowering of interest payments? How does all this work within the confines of contract law in the context of mortgage backed securities? Senior tranches may prefer foreclosure and liquidation to stretching things out and accepting lower payments - if they can even be forced to accept lower payments. But more to my point, who is going to bid a reasonable price to buy senior MBS from banks with this kind of uncertainty? Have we made the valuation problem easier or more difficult?

On the second point, taking out the most profitable mortgages, the plan makes it easier for mortgagees to refinance at lower rates. Great for them, and this gets full payment of principal into the hands of the trusts holding the mortgages, which will in turn pay off the senior tranches according to priority. That is good, for as those tranches are repaid, the securities are retired and the holders can book what is likely to be a profit. What is left, however, is truly the most toxic -- mortgages that cannot qualify even for these generous (moral hazard-inducing!) restructuring terms. What this implies for the valuation of the remaining lower tranches is probably not pretty.