JPMorgan Chase To Sell Mortgage-Backed Securities Backed By Loans In Default: Report

11/16/2011 01:52 pm ET
  • Bonnie Kavoussi Master's student in economics, the University of Michigan

JPMorgan Chase is reaching back into the playbook, and the result could help the housing market hit bottom.

The newly-minted largest bank in the country plans to sell mortgage-backed investments backed by loans in default, the WSJ reported. Other banks also are considering selling securities backed by distressed loans at bargain prices -- mimicking a plan the government used to help pull the nation out of the savings and loan crisis in the early 1990s, according to the WSJ.

The sale of loans in default could help the mortgage market recover by placing a specific price on the least desirable mortgage-backed securities, helping to restore certainty to investors about their worth.

While the mortgage-securities industry has been free-falling, there have been an increasing number of lawsuits centered on the bad mortgage-backed securities that banks packaged and sold before the financial crisis. Goldman Sachs faces lawsuits over $15.8 billion worth of mortgage-backed securities that the firm sold, including a lawsuit filed in late October by an Australian hedge fund over the infamous Timberwolf security, which a senior Goldman executive privately called "one shitty deal."

In addition to making money for banks, distressed mortgage-backed securities could help the mortgage market hit bottom and ultimately recover by placing a price, however low, on loans in default. Various former government officials, including former Federal Reserve chairman Paul Volcker, have advocated for the return of the Resolution Trust Corporation -- the agency that executed the plan, which pulled the nation out of the savings and loans crisis in the early 1990s -- since it would help restore liquidity to the markets.

Tim Ryan, a former U.S. Treasury official, wrote in The Financial Times in 2008 that through auctions of pools of bad loans, the Resolution Trust Corporation allowed frozen assets to finally have a price so that the market could hit bottom. Then, Ryan wrote, "buyers quickly returned and soon brought ever-higher bids to what had been an inoperable situation."

Investors in the Resolution Trust Corporation's mortgage-backed securities were often interested in eventually taking over the properties themselves if the loans stayed in default, according to a 1993 New York Times report. William C. Powers, then managing director at the bond fund Pimco, told the NYT then that since ratings agencies were assuming that real estate prices would continue to decline at the same rate as before, it was possible to make money from these investments simply by assuming that real estate prices would fall at a slower rate of decline.