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.

And so we're caught in a vicious cycle: More foreclosures mean more homes on the market, putting downward pressure on home prices, and making it even harder to refinance.

And lower home prices mean lenders have to take big losses when they sell foreclosed homes, making them even less willing to make new mortgages.

As the mortgage market grinds to a crawl, so do home sales, jobs in home construction and the entire economy. And that¿s behind the desperation move to pack those old mortgages into one basket. It's hoped that that might help the banks develop an appetite for making new mortgage loans.

Caught in the Crunch

While the stated purpose of this SMLEC is to bring liquidity back to the mortgage market, many analysts, including Christopher Whelan, managing director of Institutional Risk Analytics, say the super-SIV looks like a nice neat package designed to make it easier for the government to bail the banks out of their mortgage woes.

Economist Peter Morici suggests that a better solution is for the Fed to cut interest rates to give banks -- and borrowers --- some breathing room to refinance.

The downside to this solution is that it would hurt the already weak dollar. Foreigners who lend us money might start complaining about those lower rates on government securities. If our Treasury notes and bonds don't carry attractive rates, foreigners will keep selling their holdings and moving their money out of dollars ¿- a process that¿s already pushed the dollar to record lows against the euro.

As the value of the dollar declines, interest rates must rise, or the government can¿t roll over the national debt as Treasuries mature. The Fed is caught in the crunch: It needs to cut rates to rescue both home lenders and home borrowers and stave off a housing-led recession. But the Fed needs higher rates to keep selling our debt.

That's the problem with this mortgage mess. Consumers don't have a lot of room to maneuver. And neither does the government. And that's The Savage Truth.

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Terry Savage is an expert on personal finance and also appears as a commentator on national television on issues related to investing and the financial markets. Savage's personal finance column in the Chicago Sun-Times is nationally syndicated, and she released her fourth book, The Savage Number: How Much Money Do You Need? in June 2005. Savage was the first woman trader on the Chicago Board Options Exchange and is a registered investment adviser for stocks and futures. A Phi Beta Kappa graduate of the University of Michigan, Savage currently serves as a director of the Chicago Mercantile Exchange Corp. She also has served on the boards of McDonald's and Pennzoil.

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