A business editor at the Atlantic (apparently a real one) elaborated a bit today on what could happen if the banks screwed up property titles as bad as we think they did. Homeowners don’t seem to figure in much, but apparently Goldman’s screwup may give the fool investors who bought up incomprehensible mortgage-backed securities (MBS’s) a chance to take a mulligan.
The investors who hold that MBS might be able to claim that the bonds they hold were not created properly, contracts were breached, and the bank that originated the mortgages needs to buy back the bonds. This, of course, would require many billions of dollars in capital in excess of that banks have lying around. And remember these aren’t pretty bonds. They are mostly toxic and full of losses. Those losses would then be passed on to the banks.
That would be pretty sweet justice for, say, pension funds and more gullible municipalities, at least the ones that didn’t already use their MBS certificates for cigarette paper and scarecrow stuffing. However, as I recall the or at least a major buyer of MBS’s was the banks themselves. In a truly happy world the banks that got themselves deepest in this mess would spend bajillions of lawyer hours suing each other and the gains/losses will more or less cancel out.
Or maybe not.
If this problem turns out to be real, and the worst-case scenario that Rosner imagines come to be, then it’s hard to see how the government could fix it simply without tramping over contract law. Instead, more aggressive approached would be required.
For example, it could recapitalize the banks through a sort of TARP II so they could afford to repurchases these bonds. Another possibility might be to get Fannie and Freddie involved and having them buy the MBS from these investors instead, which would cause the GSEs to incur more big losses. Finally, the Fed could get involved, perhaps by purchasing those MBS as part of a new quantitative easing effort — a sort of two-birds with one stone approach. Of course, losses would again likely result — this time for the Fed. In all scenarios, taxpayers would ultimately suffer.
Just imagine the political optics of that. Permanent Republican Majority here we come.