due to borrower defaults) on mortgages F&F own or guarantee;
4) capital infusions to F&F in conservatorship on a quarterly basis depending on reported results instead of large capital infusion upfront;
5) Fire CEOs and replace the board

Points 3 and 4 are the keys to assessing the impact of this policy on US public sector finance, and consequently, US Bonds and the US$, inter alia.

Unlike the last US mortgage industry bail-out, which was financed by a combination of direct Treasury appropriations ($55.9B) and RefCorp Bond sales ($30.1B), this bail-out will not require a large upfront capital infusion, perhaps because, as the NYTimes avers, It is not possible to calculate the cost of any government bailout.

What makes calculation so difficult? The nature of a mortgage contract is a good place to start.

As Michael Lewis described so humorously in Liar's Poker, "no trader or investor wanted to poke around suburbs to find whether the homeowner to whom he had just lent money was creditworthy." Additionally, "(mortgage owners) couldn't be certain how long the loan lasted." If interest rates fell, people refinanced and that sweet 9% per annum investment turned back into cash, which could no longer be invested at 9%.

Default on one side and refinancing on the other makes analysis of mortgage cash flows more option like than bond like (admittedly, other bonds can default or be refinanced, but this is more the exception than the rule- to wit, there isn't a refinance index for corporate of government bonds, as there is in the mortgage industry).

Ever clever mortgage investors, however, found a way to hedge refinance induced discontinuities, they bought US bonds, with leverage. In that way, when interest rates declined and refinancing increased, mortgage investors had, in a sense, already invested the cash received at higher rates.

Alas, declining interest rate induced refinancing is not what ails the US mortgage market, rather it is defaults caused by rising rates (and inflation in general). The hedge which worked so well in the case of falling rates, came at the cost of increased risk under opposite conditions.

Who would'a thunk it?

It seems worth noting that one of the factors which kept US Gov't Bond rates so low while the mortgage machine was humming along was the leveraged hedge.

But, I digress. Let's try to get some sense of the risk of default, applied to the scale of the problem.

Unlike refinancing, which at least leaves investors with principal, in the form of cash, intact, default turns bond holders into real estate investors, in a falling market. I suspect neither China nor Japan is keen on owning large tracts of US suburbia, which may partially explain the attractiveness of the new policy.

As noted earlier, rising defaults seem to be a function of a combination of rising rates, particularly in the case of the ARMs promoted by Mr.