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Cracking the Crunch, by Danny Lovey, sole trader at The Mortgage Practitioner

I would like to make a suggestion as to how the problems of the outstanding MBS and their illiquidity, could be accomplished sooner, rather than later. If the timetable drags out till the next budget, in a Chancellor of the Exchequer style, it will be too late for many market participants and ultimately the consumer and the economy will suffer deeper and longer.

It certainly is not my intention to get this government off the hook for not acting sooner or more decisively, but for the common good, more action is needed sooner rather than later.

I think that an agency – that could be under the umbrella of the Bank of England, should be set up – let us call it ‘Refurbished Mortgage Backed Bonds UK, or Reback for short. The object would be that Reback would invite primarily banking institutions, who are holders of AAA Mortgage Backed Securitised bonds, and in the mortgage business, to tender to the agency the MBS for a fair market value on the assumption that all interest and capital will be repaid and their value will be determined by a panel of ‘wise men’ – experts in the field, and one or more insurance providers.

The next stage would be the Agency would ‘Refurbish’ the various
bonds, repackaging them with a view to selling into the market in a new form, sweeping away the stigma that is attached to the current MBS, even though the sterling bonds are just collateral damage from the USA fallout. After having prepared for the new Refurbished bonds to be insured in the market, and likely having them rated AAA (even though the rating agencies may not have a good record on this some institutions can only take them if rated AAA) – the price over Libor that the market would be prepared to pay for the repackage bonds needs to be sought.

Once the pricing can be agreed, it will be underwritten and that will form a tranche issued in say the Euro Floating Rate Note market and likely listed in London. The listing will be just as important for some institutions as the AAA rating. Then, within the agreement with the tendering banks will be a necessary interest differential in order to fund the likely additional spread the market may require to get the tranche of refurbished MBS away. Swaps into fixed rate bonds could also be an option. This way, I believe a sensible pricing can be arrived at where banks will be prepared for a short term cut in order to provide liquidity.

Hopefully, this will unlock the log-jam, with the banks not being so
reliant for funding supplied through Mortgage Backed Securities against Treasury note swaps by the Bank of England, (although this may also be necessary for some time if the BOE agrees to take some lesser credits on bigger margins of cover from the banks), it should provide the necessary liquidity, and purchasing institutions will think they have a good deal in order to match cash assets. If structured in the correct way, they could make ideal investments for not only some UK institutions, but many overseas ones, including investors from the East that are awash with liquidity.

If the market, the Bank of England and the FSA agreed to an Agency along the lines of Reback being formed, and presented this as a fait accompli to the Government to sort out the immediate liquidity problem as a market led solution, then attention could then be focused on ensuring that a long term solution is found that installs investor confidence in new issues of MBS by wholesale lenders.


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