With his stunning decision last week to let a federal housing agency guarantee mortgages of distressed homeowners, President Bush appears to have launched a "surge" in the financial markets to match the Pentagon's efforts in Iraq. His plan seems straightforward: First, use winks and nods to convince his top Federal Reserve appointee, Ben Bernanke, that it would be in the best interest of both men to slash interest rate targets by as much as a percentage point -- and to do it quickly so the move has time to work its magic before the next election. Second, use every lever available in the executive branch to provide a direct, emphatic bailout to overstretched mortgage holders at risk of foreclosure. And third, dump as much as possible of the financial burden for paying for the rescue of voters, aka homeowners, on the nation's banks, rather than on taxpayers. If the market comes to believe his plan will succeed -- and the plan just might -- you can expect a rally in the shares of financial-services providers and homebuilders that will stun even the bulls, with big-cap banks such as Wells Fargo ( WFC) and SunTrust Banks ( STI) rising as much as 25% over the next 12 months and some beaten-down homebuilders doubling in value.
Another Bush BailoutBush's surge solution for homeowners would, ironically, take a page from his father's rescue of Latin American governments and bankers in 1989 with a set of financial instruments that came to be known as Brady bonds. In that case, U.S. banks had lent billions of dollars to Latin American companies.
Ginnie to the RescueAccording to Bush's announcement last week of a new Federal Housing Administration program to help around 80,000 at-risk homeowners obtain debt relief -- an effort modest in scope but stunning in its reversal of prior policy -- it's clear he will go for the latter in the interest of helping his party avoid a wipeout next November.
- Banks would originate mortgage loans with 1% interest rates.
- The Federal Housing Administration and Department of Veterans Affairs would insure the loans against loss.
- The Government National Mortgage Association, aka Ginnie Mae, would buy the mortgages at par from the banks, allowing the banks to make a small profit.
- Ginnie Mae, taking a sizable loss, would then sell these loans to Fannie Mae (FNM) and Freddie Mac (FRE) at a discount so that the buyers would earn reasonable yields.
- Fannie and Freddie would fund these purchases with low-cost debt that carries an implicit government guarantee.