In the closing weeks of the election now thankfully concluded, attention focused on the failing economy and a need for the federal government to address the problems quickly and effectively. Amidst passage of the $700 billion bailout legislation, the Bush administration proposed purchase of “toxic mortgages” from major investors as a way to invigorate the economy. As expected, calls for government money emanated from those claiming to represent ordinary citizens, urging assistance for individual homeowners facing foreclosure. This dispute between Wall Street and Main Street remains heated as spokespersons from both sides press their demands.

The latest participant in this controversy is the National Association of Realtors (NAR), whose outgoing president, Dick Gaylord, criticized the U.S. Treasury Department, the overseeing authority, for “focusing too much attention and stimulus money on Wall Street and banks that are in turn using the money for mergers and acquisitions.” Not unexpectedly, the NAR prefers that the effort be aimed more toward direct government support for housing. This is but another salvo in what is currently a national contest by every imaginable group to wrest a share of the largesse. With hundreds of billions to be blown, largely by whim, and the $700 billion only a portion, there’s no limit to the variety of organizations that will haggle over the loot.

This gets us down to a fundamental question: What is the likelihood that upside down homeowners (those whose mortgage balances exceed the value of their homes) will be among the favored recipients? I believe they’ll be out of luck. With no powerful lobbying group truly representing their interests, they are odd man out. In addition, with an estimated 27% of American homeowners now in this predicament, whatever funds remain after allocation to the influential, few dollars remain for these luckless souls. Final result: Wall Street will trounce Main Street.

You’ve heard the warning: If something seems too good to be true, it probably is. I’d now like to present just such a scenario. You may decide if what I’m about to describe is believable.

Over the past several years I’ve discussed retirement programs, particularly individual retirement accounts (IRAs). Those of you familiar with me know of my bias favoring the tax-exempt Roth IRA, as well as my preference that sound, interest-bearing securities not subject to market vagaries belong in these accounts. I shall now expand on my prior analyses by carrying a specific Roth IRA investment to its logical (or perhaps illogical) conclusion.

Presume that you’re in your early 20s, your job enables you to invest $5,000 each year, and you aspire to retire comfortably at 65. In January 2008, shortly after your 25th birthday, you open a self-directed Roth IRA with a discount brokerage, selecting as its holdings certificates of deposit, treasury notes, and high grade corporate bonds. Thereafter, each January over the next forty years, you systematically add $5,000 to the account. If during that period you generate 7½% annually—a reasonably obtainable rate—you will by age 65, thanks to the magic of compound interest, possess $1.25 million in this account.

Let’s now look at the rules: “The pre-death required minimum distribution requirements that apply to qualified plans and traditional IRAs do not apply to Roth IRAs. Thus, owners of Roth IRAs are not required to take distributions by April 1 of the year following the calendar year in which they attain age 70½.” Consider the ramifications. In every year from 65 onward you may distribute to yourself, completely tax-free, the interest earned in the account ($93,750 at 7½%), while the principal balance remains untouched as it continues to earn even more tax-free interest. Somehow I don’t believe this is quite what Congress envisioned when they enacted the law.

A concluding thought:
If what I’ve just described is implemented by no more that a handful of persons, it will remain a potential bonanza for the astute few. However, if massive numbers of taxpayers avail themselves of this program, it could break the bank of the U.S. Treasury. Under that circumstance, laws would hurriedly be enacted to end Roth as we know it today.

Are you watching as the nation’s politicians work to solve the financial meltdown of 2008? Though they all have different opinions on what must be done, they seem to agree on one point: hundreds of billions in taxpayer dollars must be thrown at the problem.

The popular phrase of the moment is “bailout” with visions of the federal government buying up non-performing mortgage loans from failing financial institutions. At this point it gets confusing as our elected representatives haggle over the details. What shall we pay for these junk loans? How can we prevent Wall Street fat cats from profiting? Who will supervise the spending of all this money? Will the poor homeowners share in the bonanza? How do we make sure the taxpayer isn’t ripped off?

Amid the furor of the moment, one important question is ignored: Exactly what will the federal government receive as it shells out its money? As a long-time mortgage investor, I’m familiar with acquiring troubled loans. It’s usually a straightforward matter. We’ll take an example. John and Mary Jones purchased their home four years ago with no down payment down and a $300,000 mortgage. They’ve made no payments for the last six months and the bank holding their note is foreclosing. The question becomes, how much will I pay for this loan? What I must know is the current market value of the house—easily determined by comparisons—as well as its probable value a few years hence this takes a little clairvoyance. Let’s presume the property is worth $250,000 today and may possibly drop to $200,000 a few years down the line. On this basis, I’m justified in paying $150,000 for the note, or 50% of its face amount. As its holder, I will try to negotiate a payment schedule with the Joneses. Even at a reduced interest rate, my return will be attractive, and eventual full payoff at some future date will be double my purchase price. At worst, my completing the foreclosure and acquiring the property offers the chance to sell the house for a modest profit. This, in essence, is the heart of the mortgage loan business.

However, this is not the arena in which the bailout is proposed. It’s far more complex. The government will not simply acquire the sort of loan I’ve just described. Let me offer an illustration of the scenario faced. Five hundred loans were packaged together, known as securitized. Some are delinquent, others paying as agreed, and each with its individual terms. Then a ten percent slice of this package got sold off to an investment bank, meaning ownership of a one-tenth interest in each of 500 loans. Finally, this slice was subdivided into two portions, one of which is entitled to receive only the interest payments from the notes, whereas the other receives any principal that is paid. I defy you to figure out what either of these apparitions are worth or what you do with them after you own them.

Nonetheless, the politicos will continue to debate, and harangue, and pose for photo ops, and pretend to know what they are talking about, as they enact legislation that will take the taxpayer to the cleaners.

Welcome to our brave new world.