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Monday, December 10, 2007

Paulson's Sub Prime Plan: See You in Court?

U.S. Secretary of the Treasury Henry Paulson is arguing in favor of the administration's plans for the subprime loan crisis. Two sentences from his recent Wall Street Journal op-ed in particular struck a cord with me:

    By convening a large group of servicers and mortgage investors, we facilitated their work to improve their outreach and develop an industry-wide, streamlined response to struggling borrowers. Because these industry standards are the product of investor and servicer discussions, the risk of litigation should be manageable.

While many of the provisions in the plan are admirable and the overall goal of keeping Americans in their homes is something we are all striving for, I must take issue with Paulson's statement when it comes to the manageability of litigation. Put another way by Christopher Meyer, head of the Milstein Center for Real Estate at Columbia University's business school, "Everybody is going to end up suing everybody."

Investors in particular seem to be getting the short end of the stick, specifically with respect to the freezing of adjustable rate mortgages set to adjust higher. Pension fund managers, plan sponsors, hedge funds and even institutional individuals have significant investments in collateralized debt obligations (CDO) or related investments tied to subprime loans. The rate of return for many is tied to adjustable rate mortgages, which were supposed to increase as stipulated in the mortgage contract.

It's very simple: if an investor buys a security that is suppose to generate a five percent return, then if it's going to be changed, either the buyer needs to sign off or they need to be compensated for the reduction. In my mind, Paulson's plan is tantamount to a bail out of Wall Street. Wall Street contributed greatly to the housing bubble by packaging and selling toxic subprime loans to investors perpetuating their use even further, therefore Wall Street should bear the brunt of the losses due to contract renegotiations, not the investors themselves.


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