Mortgage backed surprises?

By DAVID MOON, Moon Capital Management
April 29, 2007

I don't always anticipate which specific risks might reach up and bite me in the assets.

As a professional money manager with supposedly impressive initials after my name, I thought I had considered most types of hidden risks. But your elected officials just threatened us with one completely out of the blue:

You may be responsible for the mess in the subprime mortgage market.

If you own any mortgage-backed bonds or you are invested in a bond fund which owns bonds issued by folks like Fannie Mae, the top Democrat and Republican on the House Financial Services Committee say you ought to be held liable if those bonds are used by banks to loan money to people who can't afford it.

Huh?

Chairman Barney Frank (D., Mass.) and Spencer Bachus (R., Ala.) argue that investors who buy these bonds make it possible for banks and other mortgage originators to make risky mortgage loans. If the capital wasn't so readily available from bond investors, the banks wouldn't be so anxious to make all those subprime loans.

'More money was being lent than should have been lent,' says Frank. Given that 87 percent of the subprime mortgages are not in default, I wonder which of those homeowners he thinks should not have been granted a loan.

No specific legislation is pending that would place liability for failed mortgages on the investors in the bonds. But Congressman Frank predicts that a bill will pass the House this year. He says that the mortgage-bond market has provided 'liquidity without responsibility.'

Did you realize you were being irresponsible when you were just trying to get a little extra yield on your bond fund?

But what about the responsibility of the people who borrowed the money in the first place? 'Well, I just figured if the bank would loan me the money, that meant I could afford it.'

I suppose it's asking too much for a bill outlawing stupidity.

I would be amazed if Congress passed a law that assigned liability to holders of existing bonds. But it wouldn't be the first time our elected officials, the servants of the people, passed some strange and painful retroactive legislation.

What Congressmen Frank and Bachus seem to overlook is that holders of mortgage-backed bonds already bear liability in the subprime mortgage market. Those subprime loans are the collateral for $540 billion of the $2.12 trillion of mortgage-backed bonds that were sold in 2006.

If enough borrowers default on their loans, it's not the banks that lose ' and it's not the homeowners who are the biggest losers. By far, the biggest potential losers are the folks who funded those loans in the first place.

And we don't need any additional legislation to create that potential liability.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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