Put all of your rotten eggs in one basket and tie a bow on it -- that¿s essentially what a plan to save the big money center banks from taking huge losses on bad mortgages entails.But if this fiction makes it easier for the millions of homeowners who need to refinance their adjustable-rate mortgages, then it might be worth a try. Even so, we should be under no illusion about what's really happening. Last week, several big banks, including Citigroup ( C), J.P. Morgan Chase ( JPM) and Bank of America ( BAC), agreed to take all the mortgages they hold in off-balance sheet subsidiaries called "structured investment vehicles," or SIVs, and put them into one big, super-SIV called a single-master liquidity enhancement conduit, or SMLEC. That combined pool of securitized assets could hold as much as $75 billion of mortgages. It's hoped that this "super-SIV" will be able to sell commercial paper, which presumably will be rated investment grade because the government will give it some sort of seal of approval. No details have been released on that aspect. These days, few investors want to buy the commercial paper backed by mortgages in banks' existing SIVs. The ratings agencies, which previously said that paper should carry a double-A rating, have belatedly downgraded them to junk. Pooling these questionable mortgages in a super-SIV is more attractive to banks than the alternative, which would be to bring them onto their balance sheets. Doing so would force them to revalue the loans and take a big hit to their capital. And that would really impinge on the banks' ability to make new mortgage loans. Will SMLEC Help Homeowners? One thing the SMLEC won't do, and can¿t do, is resolve the problems of the millions of American who are suddenly finding they can¿t afford the rising monthly payments on their adjustable-rate mortgages. That¿s because, once a mortgage is repackaged as collateral for commercial paper or other kinds of securities, it's not possible to modify the terms. This limits the workout options for borrowers who run into trouble. There is one way out. You can refinance the house with an entirely new mortgage and pay off the old, ugly mortgage. But that isn't easy these days for three reasons:
- Many of these adjustable rate mortgages carry steep prepayment penalties.
- Falling home prices mean that many homes will no longer appraise for the amount of the existing mortgage.
- Many people who received mortgages based on just "stating" their income will now be subject to close scrutiny of their income, and will no longer qualify.