Second Liens and Firsts

http://www.futureofcapitalism.com/2011/03/second-liens-and-firsts

From a column in today's New York Times provided by ProPublica, a non-profit news organization:

Bill Frey, who runs Greenwich Financial Services, has instigated lawsuits to try to recoup the value of mortgage securities by getting the banks to buy back faulty mortgages that were in the pools he examined....

Mr. Frey argues that the banks should charge off those seconds. "That's the concept of subordination," he said. "It's been around since the Magna Carta. Maybe we should get on the bandwagon."

This is not simply a fight between hedge funds, which own the securities that contain the first liens, and banks that house the seconds. Many mortgage securities are held by small banks, life insurance companies and pension funds. "I can see little reason why a pensioner should take the loss instead of Bank of America, when it's Bank of America's bad loan," Mr. Frey said.

This idea that these losses should be allocated or reallocated based on how sympathetic or deserving the entities receiving the losses are is a flawed one. After all, pension funds and university endowments (financial aid for poor scholarship recipients! funding for cancer research!) invest in hedge funds and in shares of large banks, too. Many pensioners are guaranteed their benefits regardless of the pension fund performance, so the loss comes not from a pensioner but, in the case of a government pension fund, is made up by the taxpayer, or, in the case of a private pension fund, shareholders. And while the columnist throws "life insurance companies" in there with the small banks and the pension funds as if they are somehow especially sympathetic characters like the widows and orphans who benefit from life insurance policies, it's not clear to me that they are inherently more deserving or sympathetic than banks. AIG, after all, was a life insurance company. Better to stick to a rule of law that applies impartially to everyone, whether they are a pensioner, a life insurance company, a large bank or a small bank.

by Ira Stoll  |  Mar 17, 2011 at 9:07 am Related Topics:  AIG, Banking, Capital Markets Regulation, Non-Profits receive the latest by email: subscribe to the free futureofcapitalism.com mailing list