Fred Feldkamp: Agenda Items for Lame Duck Congress to Fix the US Economy

In this issue of The Institutional Risk Analyst, IRA Vice Chairman Christopher Whalen reviews some reader comments and press reports further to last week's missive, "Can Pent Up Supply Overcome Systemic Inaction?," as well as some earlier contributions.

Our friend Fred Feldkamp wrote a long comment last week on why the Fed should do QE3 to help the mortgage sector.

"If implemented, the proposed QE 3 uses the Fed's power to create a "riskless arbitrage" to narrow the spread between long-term (10-year) Treasurys and long-term fixed rate mortgages. A relative reduction in Treasury bonds held by the Fed pushes long-term Treasury rates up (at 1.8%, the 10-year was at record low rates) while a mortgage QE 3 will stabilize long term mortgage rates, keep them from rising rapidly or actually push them lower," Fed argues.

We are less sanguine about the efficacy of further Fed intervention in the bond market via QE3, especially given the cartel behavior of the large banks and housing agencies in refusing to refinance the bottom third of the US mortgage market - a mere 25-35 million households. But Fred offers some hope here in his three final recommendations of action items for the immediate post-election period at the end of 2012:

"So, what's left to do if the Fed succeeds with a QE 3?

A) Restore the power of non-banks to do well-structured securitizations (under SEC '40 Act Rule 3a-7) that access money market funds for short term funding on a demonstrably safe basis by properly amending '40 Act Rule 2a-7 to allow well-structured pools of "current assets" the access they had before the ludicrous 1998 amendments to Rule 2a-7 that created the bank "monopoly" of money market funds which eventually generated the 2008 "uber-crisis."

B) Allow long-term rates to rise relative to short-term rates (within limits of course) until new investment vehicles are created by financiers that profit by creating private sector "riskless arbitrages" ...

C) Fix the Bankruptcy Code so lenders rights are preserved by the "indubitable equivalent" of their current first mortgage liens and allow bankruptcy judges to wipe out the rest of the unrecoverable mortgages--even if that requires the receivership of several major entities under the "Orderly Liquidation Authority" of Dodd-Frank.

Get everything ready so Congress can adopt necessary changes during a "lame duck" post-election session (allowing the next Congress to "blame" the current Congress when facing inevitable criticisms). Those changes will create the "fresh start" that the nation (and the world) need in 2013."

We completely agree with Fred that fixing the 2005 bankruptcy "reform" legislation, which has effectively placed second lien holders ahead of first liens in the mortgage market, must be a national priority. When a borrower files bankruptcy, everything but the first lien mortgage should go, then the Court should see if that aspect of the borrower's estate can be salvaged.

As we've noted in The IRA, the 2005 bankruptcy reform law turns the entire world on its head and forces first lien investors to take losses before second liens -- precisely what the large banks desired. Just as WalMart (WMT) pushed the Durbin Amendment to the Dodd-Frank law in order to sipohon more profits out of banks via lower ATM interchange fees, the big banks have used bankruptcy reform in 2005 to protect half a trillion in worthless second lien exposures on residential homes. In both examples, consumers and the US economy are the losers.

As one senior banker told The IRA: "Dick Durbin is the Senator from WalMart, plain and simple. The Durbin amendment pushes down what banks are allowed to charge for clearing ATM transactions, arguably below the cost of providing the service. WalMart has pocketed billions in profits via lower point-of-sale transaction costs. None of that money will go to consumers. And banks must now raise fees on other services to compensate. The whole point of ATM cards is to help consumers avoid debt, but now you will see vendors pushing the use of credit cards instead of ATM cards."

In terms of our comment advocating a reorganization of Bank of America, "Should the Courts Appoint an Equitable Receiver for Bank of America?," Henny Sender of the Financial Times reported on January 19th:

"Wherever he goes, Brian Moynihan cannot escape the question. Investors, analysts and industry rivals all want to know whether the Bank of America chief executive will seek bankruptcy protection for Countrywide, the mortgage provider that his group bought near the top of the market. In public, he has responded carefully. Annual results released yesterday passed without direct mention of plans for the home loans unit. At a conference last month, Mr Moynihan said only: "We look at all options for Countrywide."

But interviews conducted by the Financial Times reveal that he has been rather more forthcoming in private. More than a year ago, Mr Moynihan confided to a Wall Street chief executive that if he did not kill Countrywide by placing it in bankruptcy proceedings, he feared the mortgage unit would kill the bank, this executive says. Last September, on the sidelines of the International Monetary Fund/World Bank meetings in Washington, Mr Moynihan told one investor that a filing would be complicated but he did not dismiss the possibility. "If it were simple, we would have already done it," he said, according to a participant in the conversation."

Of course, we continue to believe that the strategy of filing Countrywide or the Rescap subsidiary of Ally Financial is not a viable strategy, but as one veteran lawyer told us several years ago with respect to Bank of America, it makes an interesting negotiating strategy.

In this regard, we must note that Global law firm White & Case LLP announced January 9th that it is representing a group of bondholders, including institutional holders and secondary holders, with more than $800 million of secured bonds from Rescap. Gerard Uzzi of White & Case, who is representing the group, stated: "Ally, Ally Bank and Rescap are too intertwined to be easily unwound. A forced Rescap filing would be a big mistake and create significant litigation against Ally."

Ditto Gerard. That is why the parent of Bank of America or the parent of Rescap must file and seek the protection of the Bankruptcy Court for the entire group a la Lehman Brothers. As we have noted over the past four years of fun and games with the folks at Bank of America with respect to Countrywide, you cannot file bankruptcy for the affiliate of a bank holding company because the creditors will immediately attack the parent company. Period, end of story.

In our December 20, 2011 comment, "Leland Miller: The Crisis Ahead for China's Policy Banks," we suggested that China's version of Fannie Mae and Freddie Mac poses a threat to the country's financial health.

But a reader named Richard in CT writes: "Re-read Leland Miller's article in Dec 20 IRA. Not sure 'crisis' is the right word. Seems more simply a burdensome load."