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December 6, 2007

Subprime: Sense and Nonsense in the Bailout

My friend Nouriel as a typically lucid comment on the subprime bailout. A snippet:
What one should thus clarify is a lot of the nonsense that one has heard in the last few days about this proposal. This nonsense takes many forms but here are some variants of it:

“It is an illegal breach of contracts to modify such contractual agreements”;

“Investors in RMBS and CDOs will suffer sharp loss given this forced mortgage modifications”;

“Domestic and foreign investors will be wary of buying such assets in the future given this ‘forced’ modification of the contracts that inflicted losses on them”.

All these statements are utter nonsense and betray basic ignorance of the process and substance of bankruptcy. One thing should be clear at the outset: investors in these assets will be much better off (i.e. the value of their claims will be higher than otherwise) with this proposal rather than the alternative of letting millions of homeowners default on their mortgages.

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Comments

1. Comment by dub dub -- December 6, 2007 @ 12:28 PM

The posted link is verbose, not lucid! I bet this guy has a PhD.

Point 3 is not nonsense -- it just means the risk (interest rates required) for those things will be higher in the future, maybe much higher. The investors grossly underpriced the risk, and were not compensated for this shitstorm.

And point 2 might be valid too -- the modified loans may "really" be in default, but the holders won't have to write them down yet (but they will) Awesome!

I think this whole bailout is a fantastic idea because it slows the rate of defaults (giving the markets time to much thru things); it won't prevent them.

But what do I know -- atleast I'm terse :)