Columbus Loans & Home Mortgages

Yesterday was a great day on Wall Street. The Dow gained almost 500 points.

Earlier in the day the government announced its plan to deal with so called toxic assets. These are basically home loans on homes in default, which banks can’t sell on the secondary market, i.e. to other banks or investors. We all know that banks have plenty of these Columbus loans, and that they are the main reason why banks don’t lend.

To help banks get rid of these toxic assets the administration unveiled a private-public partnership as a way to buy these loans.

Let’s use a simple example to demonstrate how this program is supposed to work.

Let’s say a private investor puts up $1. The government matches this investment with another $1. Now we have $2 of equity. In addition, the government agrees to leverage these $2 by a loan of up to $12. All together that’s a $14 investment fund we can use to purchase bad loans from banks. The private investors control the investment, the government secures most of the money invested.

Obviously, the partnership funds will try to buy the toxic loans as cheap as possible. The Fed assumes that banks will sell these loans for 40 to 60 cents on the dollar.

The private investor is at risk for $1, but will fully participate in the upside. An upside happens when the toxic loans acquired by this partnership produces more than $14 in return. If the deal goes belly up, i.e. our new fund loses money, then most of the loss will be carried by the taxpayer, which obviously owns or secures $13 of the $14 fund.

You may wonder how this program will effect an individual home owner who may have one of these Columbus loans ? Initially, it won’t, as long as mortgage payments are current. If the loan is in default, these new funds will be more flexible than banks. I assume they will negotiate short sales rapidly to sell the loans at a loss or even push foreclosures. But they will also be more creative when it comes to restructuring loans and convert these loans from toxic into performing assets.

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