"has started to buy securities backed by residential mortgages"

Here's an interesting story in the FT:

"John Paulson, the hedge fund manager who was called before Congress last week to discuss the big profits he made by foreseeing the collapse of the subprime mortgage market, has started to buy securities backed by residential mortgages.

Mr Paulson’s move marks the latest example of a famously bearish investor shifting gears to profit from depressed prices in the global credit markets.

US residential mortgage securities fell in value last week after Hank Paulson, Treasury secretary, said that the federal government had decided against buying toxic assets as part of its $700bn troubled asset relief programme (Tarp).

John Paulson, who is not related to the Treasury secretary, has told his investors that he started buying troubled mortgage-backed securities at the end of last week, hoping to capitalise on price falls that followed the Treasury announcement."

So, the chain of events:
1) TARP won't buy toxic assets
2) Toxic assets decline in value ( Now, what does that tell you? )
3) J. Paulson buys toxic assets

So, how long is Paulson planning on holding these toxic assets:
1) Short term ( Does he think that government will intervene? )
2) Long term ( They're going to appreciate? )

By the way, I was very impressed by his testimony before congress.

Here was his plan to help stop foreclosures:

"By providing funding and other support for attorneys who can
review loan documents and negotiate with loan servicers, we believe that many more
homeowners will be able to stay in their homes."

Here was my comment, where I tend to agree with him:

Since this is mainly legal help, and the loans are called abusive, maybe we should be doing what I say, which is examine the legality of these loans.

Here's a quote:

"This mechanism M_ purchases of senior preferred stock with warrants in troubled
institutions -- addresses the problems with the Treasmy plan. The financial
market is stabilized, companies get recapitalized, failures are avoidedJ debt
securities are supported, and time is gained for illiquid assets to mature.
The institutions continue to function, their cost of funding will decline as equity
capital increases, and innocent third parties like bank depositors, broker/dealer
clients and insurance-policy holders are all protected. The only difference is that
potential losses are kept with the shareholders where they belong."

Is he betting on the long term, hoping that the government will buy this stock and allow illiquid assets to mature?

"For several months Mr Paulson has been considering investing in distressed subprime mortgage securities, financial firms and debt used to back private equity deals.

He estimated there are $10,000bn in total in such assets."

Okay.

"In a letter to investors at the end of the third quarter, Mr. Paulson said his strategy was “to reduce leverage, maintain market exposure and maintain short credit bias”. He said: “The majority of our gains came from short positions in the equities of declining financials and CDS [credit default swaps] on financials. Generally our short exposure has been reduced as many of the companies we were short have failed.”

Mr. Paulson’s plans come at a time when other leading investors, including Jeff Aronson at Centerbridge Partners and Bruce Karsh at Oaktree Capital, are wading into the market for discounted leveraged buyout loans."

We'll keep an eye on this.

"Mr Paulson, who has $36bn under management, was scheduled to hold a dinner and wine-tasting at New York’s Metropolitan Club on Monday night so that he could brief his investors on his plans.'

I'm planning a hunk of Stilton, Bread, and Two Buck Chuck for my readers.

Henry Blodget on Clusterstock seems to believe that it's 2:

"John Paulson Goes Long: Buying Subprime And Other Mortgage-Backed Securities

One of the few folks who made a killing on the housing crash, John Paulson of Paulson & Co., has now started betting on a recovery. His plans to do so filtered into the market a couple of months ago, when he began raising the Paulson Recovery Fund, but now he's actually started buying"

"The way to do so is through the shared appreciation mortgage, or SAM. " Sam I Am.

Greg Mankiw considers a proposal to renegotiate mortgages and stop foreclosures:

"I can see the attraction of these ideas, but I have two questions:

1. Would a law giving homeowners the right to write down their mortgages in exchange for equity attract so many homeowners that financial institutions would suffer even bigger hits than they already have? As these authors note, foreclosure is unpleasant for everyone. But because it is so unpleasant, some homeowners who are underwater on their mortgages keep paying them anyway. If we give them a better alternative, why would they?
2. If Congress were to pass a law allowing homeowners to rewrite their mortgage contracts, and lenders suffered losses as a result, what would the constitutional implications be? The fifth amendment says "nor shall private property be taken for public use, without just compensation." Could lenders get "just compensation" for losses that resulted because Congress crammed down an equity-for-debt swap? If so, would this be the best use of taxpayer funds?"

He then gets answers:

"In response to the first question, he writes:

The offer would come from the lender (not borrower) in cases in which there is a stop in payment on the mortgage. Offering this on top of a standard write-down is an option that is currently not in their arsenal, a fact that many of them are not aware of (essentially ruled out by the tax code). One offers incentives for the writedown e.g. by exempting the shared appreciation strip from capital gains taxes. This is then part of the workout routine that would be far more attractive than a pure write-down, and often superior to enforcing default.

Suppose someone stops payment on their mortgage without needing to just because this offer is potentially open. They can be offered some powerful discouragement: (a) Increasing share of appreciation with increasing write down; (b) Give lenders ability to check income. There would then be a high % dedicated to the loan (you won't want this if you are doing fine or expect to recover income); potentially, have payments on the mortgage rise with income if one needs to work this angle harder.

The complete incentive system could be designed in a dynamic manner, adjusting as evidence of excessive use came to light.

In response to the second question:

This would be voluntary negotiation. The idea would be to set up the incentives for it in the tax code. It simply dominates current options in most circumstances."

I would have thought that the answer to both questions would be that the lender makes the ultimate decision. If payment stops, and he doesn't feel the offer is kosher, he can foreclose. In any case, since it's a negotiation, he can say yes or no. All this program does is give government inducement for mortgage renegotiation instead of foreclosure.