“Backing paper money with mortgages is nothing new. The French tried it in the late 18th Century, and it lead to hyperinflation.”
- Peter Schiff


Peter Schiff makes some interesting — and alarming — observations about the mortgage crisis in America:

This week, as the financial sector began to give way under the unbearable weight of bad mortgage debt, the Federal Reserve stepped in to save the day. At least that’s what it says in the script.

In a surprise move, the Federal Reserve announced its intention to swap $200 billion of treasury debt for $200 billion of potentially worthless mortgage-backed securities. The Fed may have been partially spurred to take the step as a result of the rapid collapse of Carlyle Capital Corp. a publicly traded private equity firm that is a subsidiary of the Carlyle Group. The Dutch firm could not meet margin calls on its depreciating collateral of AAA-rated mortgaged-backed securities guaranteed by Fannie Mae and Freddie Mac. On Friday, the Fed then took the unusual step of providing emergency “non-recourse” funding to Bear Stearns, collateralized by that firm’s similarly worthless mortgage debt. Apparently the Fed now stands willing to assume any mortgage-related risk that no other private entity would touch.

… According to the Fed, its new plan does not amount to buying mortgages but simply accepting them as collateral for 28-day loans. However, will the Fed really return these ticking time bombs to their true owners in 28 days, inciting the very collapse its actions were originally designed to postpone? Why does the Fed believe that the mortgages will be marketable next month; or the month after that?

… The problem with these mortgages (other than the borrowers lacking any means or desire to repay them) is that the underlying collateral is worth a fraction of the face amount. With recent foreclosure recovery rates amounting to less than 50 cents on the dollar, it is no wonder that no one wants them. The real estate bubble allowed borrowers to leverage themselves to the hilt using inflated home values as collateral. However, now that the bubble has burst, mortgage balances far exceed current property values. It is a trillion dollar time bomb that no one can possible defuse.

Paper dollars are technically Federal Reserve Notes, which means they are liabilities of the Fed. When it puts newly minted notes into circulation it does so by buying assets, usually U.S. treasuries, which it then holds on its balance sheet to offset that liability. By swapping treasuries for mortgages, the Fed effectively alters the compilation of its balance sheet and the backing of its notes.

… Backing paper money with mortgages is nothing new. The French tried it in the late 18th Century, and it lead to hyperinflation. Assignats, which were first issued in 1790 to help finance the French revolution, were backed by mortgages on confiscated church properties. Although the stolen underlying collateral did have some value, the revolutionaries saw no reason to limit how many Assignats were printed, which resulted in massive depreciation. Within three years, price controls were introduced and failure to accept Assignats, initially an offence subject to six years in prison, was made a capital crime. By 1799 the currency was completely worthless.

- Peter Schiff @ For Sou 15 Mar 2008: Link.

- Prise de la Bastille by Jean-Pierre Houël: Link.