Forget Political Rhetoric: Bailout will not save the economy – Part 2

In Part 1 of this article, I discussed the fact that the U.S. Government’s “rescue plan” would not save the economy because it fails to address the underlying cause: the collapsing housing sector.  I explained that the U.S. would be powerless to curb the avalanche of foreclosures (10,000 per day as of this writing) because it would not actually own mortgages, but instead, it would merely hold mortgage-backed securities, known as certificates.

As a result of owning just a bunch of worthless certificates held in securitized trusts, the U.S. does not have the power to engage in mortgage modifications without altering the Pooling and Servicing Agreement (PSA).  The U.S. would have to control 67% of the certificates of each securitized trust to amend the PSAs.

However, even assuming Uncle Sam did control 67% of all of the securitized trusts, it still would not alter the PSAs because that would destroy the tax-free status of these trusts.  Each mortgage-backed security trust is defined by the IRS as a Real Estate Mortgage Investment Conduit (REMIC), which allows all profits to pass to certificateholders without taxation at the corporate level, for so long as the trust abides by the strict REMIC rules. 

If a securitized trust loses its REMIC status, its certificate holders will suffer massive losses as their investments are taxed at both the corporate and individual levels.  So, losing REMIC status for a securitized trust would hurt individual investors and taxpayers because it would dramatically reduce certificate values, and once REMIC status is lost, it is lost forever.   This is just one more reason why the rescue plan will not save the economy.