by Tanta on 8/14/2007 12:41:00 PM

Now this, I admit, is an idea that never crossed my mind:

If the assets held by the hedge funds are sound, and it’s just an issue of stemming a momentary panic, then the Fed should step in as lender of last resort and try to stabilize the market. However, if the issue is just one of giving the hedge fund crew time to dump their bad debts, then the Fed has no business getting involved.

A quick look at the evidence strongly argues for scenario # 2. The problem is that homes are worth less than the value of the mortgages. This is the main fuel for the surge in defaults. This process will only get worse as house prices continue to decline. With the inventory of unsold new homes more than 50 percent above its previous peak, and the number of vacant ownership units nearly twice the previous record, there can be little doubt about the future direction of home prices.

One final point: the hedge fund crew may try to take the homeowners hostage, arguing that the only way to keep millions of low and moderate income homeowners from being thrown out on street is to bailout the hedge funds. This is not true. Congress can just pass legislation that allows homeowners who default to remain in their house as renters, as long as they pay the fair market rent (as determined by an independent appraisal) for their home.

We must be careful not to confuse the plight of distressed homeowners with the plight of the hedge fund crew. As we all know, you can never give in to hostage takers, especially if they run hedge funds.

Hmmmm. Overnight, turn all those CMOs and CDOs into REITs that hold income-producing REO instead of mortgage loans . . . CPR (prepayment rates) go to zero . . . trustees develop new skills as they review remittance reports and come unplug your sink . . . I'm liking this . . .