“Institutional investors, pension funds and hedge funds all have fiduciary obligations and they can’t necessarily agree to haircuts solely because it may be good social policy,” Sylvie Durham, an attorney with Greenberg Traurig in New York, who practices in the structured finance and derivatives area.
Tad Rivelle, chief investment officer of fixed-income securities at TCW, which manages about $120 billion of which $65 billion is in U.S. fixed income, doesn’t support a big haircut. But he says he can see why some economists and consumer advocates would favor debt reductions and debt workouts as way of dealing with the financial crisis and freeing up more money for spending.
Barry Ritholtz, director of equity research at Fusion IQ and a popular financial blogger, said the standoff between the banks and bondholders is untenable and doing a good deal of harm. An early critic of the bank bailouts, Ritholtz says bankers and bondholders are all in denial and both need to get far more pragmatic.
“They’d be bankrupt if not for the bailouts,” says Ritholtz of the banks’ position. “For their part, bondholders need to understand that we’re not earning our way out of this mess and should eat losses now before they get nothing.”
Time for a mediator
Given the standoff, there’s a sense nothing will happen unless federal policymakers make the first move. The Fed reports that 71 percent of household debt in the U.S. is mortgage-related.
But so far Washington policymakers seem more content to rely on voluntary measures. The two main programs set up by the Obama administration to reduce home mortgage debt – the Home Affordable Refinance Program and the Home Affordable Modification Program – have had limited success.
To date, the Treasury Department reports that those voluntary programs have resulted in 790,000 mortgage modifications, saving those borrowers an average of $525 a month in payments. Many of those modifications, however, were for borrowers paying high interest rates, not ones underwater on their mortgages.
In fact, Bank of America, one of the nation’s largest mortgage lenders, said it has offered just 40,000 principal reductions to its borrowers.
Administration sources told Reuters that they support the concept of carefully targeted principal reductions for underwater borrowers. But these sources, who did not want to be identified, say the administration cannot mandate banks and bondholders to accept any principal reductions absent Congress authorizing the procedure.
The sources point out that federal authorities don’t have a “magic wand” – even at Fannie Mae and Freddie Mac, the government-backed home-loan titans.
These sources explain that even though Fannie and Freddie are effectively owned by the federal government, they are controlled by an independent regulator, the Federal Housing Finance Agency. And it’s up to the FHFA, and not the administration, to approve any principal reductions on home loans involving Fannie and Freddie.
An FHFA spokeswoman declined to comment. The agency has repeatedly taken the position that its first job is protect taxpayers’ return on investment in Fannie and Freddie rather than reducing mortgages for underwater borrowers.
Clock ticking
The fear of some economists is that the economy may be going into a double dip recession. That means precious time is being lost if a negotiated approach to debt reduction isn’t taken now.
But the banks also have their own big debt burdens to deal with. Next year alone, banks and financial institutions must find a way to either pay off or refinance $307.8 billion in maturing debt, compared to the $182 billion that is coming due this year, according to Standard Poor’s.
This maturing debt for banks comes at a time when they must start raising capital to deal with new international banking standards and are facing the possibility of a new recession that will crimp earnings.
Beyond bank debt, hundreds of billions of dollars in junk bonds sold to finance leveraged buyouts also are maturing soon. SP says “the biggest risk” comes in 2013 and 2014, when $502 billion in speculative-grade debt comes due.
Still, there are still plenty of economists who say the concern about consumer debt is overdone and that doing anything radical now would only make things worse. One of those is Mark Zandi, chief economist of Moody’s Analytics, who says a forced write-down or haircut of debt “would only result in a much higher cost of capital going forward and result in much less credit to more risky investments.”
He said significant progress has been made in reducing private sector debt, and draconian debt forgiveness measures would be a mistake. “Early in the financial crisis I was sympathetic to passing legislation to allow for first mortgage write-downs in a Chapter 7 bankruptcy, but the time for this idea has passed,” says Zandi.
Still, the notion of a debt write-down and bondholder haircuts will probably be around as long as the unemployment rate stays high and the housing market remains depressed.
Indeed, it has been two years since the notion of a “Debt Jubilee” made it into the popular culture when Trey Parker and Matt Stone used it for an episode of the politically incorrect cartoon “South Park.” In the episode aired in March 2009, one of the characters used an unlimited credit card to pay off all the debts of the residents of South Park to spur the economy.
At the time, the idea seemed like just a funny satire on the nation’s economic mess. But now it seems like no joke at all.
Copyright 2011 Thomson Reuters. Click for restrictions.