I mean, give me a break:

"Federal Deposit Insurance Corp. Chairman Sheila Bair is finalizing a legislative proposal that would allow the Treasury Department to make direct loans for close to one million homeowners in the latest government initiative to stabilize the slumping mortgage market"

Sounds good right? Read on....

"According to the draft, borrowers would still be required to pay their mortgage and the new government loan, but they would not have to make any payments on the Treasury loan for the first five years. During that time, investors in the loans would pay interest to Treasury, and after five years homeowners would begin repaying the Treasury loan at fixed Treasury rates.

For loans to qualify, mortgage investors would "pay Treasury's financing costs and agree to concessions on the underlying mortgage to achieve an affordable payment."
To modify one million loans, the FDIC estimated it would require a $50 billion public debt offering. Treasury would recoup the costs because it would have the first priority to recover funds if homes are sold, refinanced, or if the borrower goes into default."

The last sentence is key.

Is Sheila short every bank and institution that holds mortgage-backed paper?

Because I will be if this passes.

Why?

That last sentence.

This sort of "modification" (no doubt implemented with lots of arm-twisting by government) will instantaneously mark all the mortgage paper outstanding at about 5 cents on the dollar, which is roughly where all the HELOCs and Second Liens are trading now.

Right now first mortgage lenders have priority in a foreclosure. That is, they get all their money first, then if there is anything left the seconds and HELOC guys get to fight over what's left.

This reverses that priority so that Treasury gets all its money back first, then, if there's anything left, the lender gets theirs.

The instantaneous impact of this in the lending market would be an extreme blowout in spreads over Treasuries for all new mortgages, along with an immediate markdown of 20% off principal value on existing paper from where it is now. The blowout in spreads would be an effective monster interest-rate hike, which would immediately "mark to market" the entire housing stock down by the change in affordability (e.g. if it was, say, a 200 bips spread, going from 6-8%, it would hit every home in the nation for about 28% of its value instantaneously. Yes, on top of the damage already done and the normal devaluation to come.)

Since a lot of that paper that would be covered by this (e.g. ALT-A, etc) is underwater at the present time and likely worth 50 cents, this inversion, plus the immediate markdown caused by the spread blowout would leave the "first" lender with paper that would be lucky to fetch a bid of any size.

You couldn't do something more damaging to the mortgage and housing market than this.

Seriously.

Call Congress (again) and (politely) suggest that Ms. Bair grow a brain.

Oh, and while you're at it, add that Congress needs to stop this sort of stupidity. Time to get on the phone. Again.

(Want it in video format? Go to http://www.tickerforum.org/cgi-ticker/akcs-www?post=42539

PS: Some people already have. With direct action. This, my friends, is what its all about.