"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"

"basically breaking with the rest of the administration and hoping the Congressional Democrats can make it happen."

Baseline Scenario on the FDIC proposal for mortgage relief:

"This plan (which we’ve heard about in some form or another for weeks) would apply to all owner-occupied homes that are at least 60 days past due; mortgages would be reduced so monthly payments are no more than 31% of the borrower’s income. Based on FDIC experience at IndyMac, most of those reductions would be made by reducing the interest rate as low as 3% and extending the term; principal would only be reduced in a small number of cases. (From a net present value perspective, of course, lowering the interest rate and lowering the principal are two ways to get at the same thing.)

Because the government does not have the power to force loan servicers to modify loans, the incentives would be a $1,000 fee per restructured mortgage and, more importantly, a government guarantee for up to 50% of the loan value in the case of a re-default. Participating servicers would also have to systematically review their entire portfolios for loans eligible for modifications, to prevent them from picking and choosing. The FDIC’s high-level estimates are that 4.4 million loans will become sufficiently past due by the end of 2009, 2.2 million could be modified, and 1/3 of those will re-default; the total cost to the taxpayer would be $24 billion, mainly for paying off the guarantee on defaults.

The basic principle of the plan is sound: providing a government incentive to get servicers to do something that will help borrowers and the communities they live in. However, I don’t see anything in it that will get around the securitization problem - servicers are legally bound only to act in the interests of the investors who own the bits and pieces of the loan, and some of them may sue if loans are modified in ways they don’t like. Solving that problem will almost certainly take new legislation."

So:

1) 60 days since payment

2) Payment reduced to 31% of income

3) Reduce interest rate on loan

4) Extend term of loan

5) Lower amount of loan ( Rare )

6) $1000 per mortgage to loan servicers

7) FDIC guarantee of loan value if borrower defaults again

8) Servicers must disclose who's eligible

Problem:

1) Servicers can still be sued by the lenders

Okay. This plan gives an incentive to the servicer by paying them a fee. However, the lender can object if they don't like the terms.

Since the government can't force anyone into this plan, it will be up to the servicers and lenders to accept these terms or not.

The FDIC is linked by me in the other sites area.

But get this, as reported by Baseline Scenario whose analysis I liked:

"By the way, this is Treasury’s response, according to the AP:

[FDIC] officials want to use part of the $700 billion bailout of the financial industry to pay for it. But the Treasury Department is opposed to that idea.

Testifying on Capitol Hill Friday, Neel Kashkari, the Treasury Department’s assistant secretary for financial stability, said the intent of the $700 billion plan was to make investments with the hope of getting the money back. That, he said, was “fundamentally different from just having a government spending program” that would disburse money with no chance of ever seeing any returns.

Is there really a fundamental difference between (a) making investments that theoretically could get a positive return but are really bad investments you are consciously making to shore up the financial system and (b) extending loan guarantees that you know will cost you some money, but will help stabilize the housing market, increase state and local tax revenues, and keep people in their homes?"

There is a difference. The question is whether either is a wise use of taxpayer's money. I'll be honest. I don't like either plan, because there are too many variables that can add cost and lessen effectiveness. However, if they do this, I hope that it works.