These Bonds are each made up of hundreds, even thousands of individual mortgages such as yours and mine.

Currently only 7% of all mortgages in the U.S. are in default. Even assuming they all go to foreclosure the Lender still only loses a small percentage of the total mortgage value once the property has been resold. Let’s allow for a loss of 25% of the original value on 7% of all the mortgages in a given $20 million bond. That equates to a $350,000 loss.

For our purposes let’s say the interest rate on the Bond was 6%. That’s $100,000 per month income.

Now let’s see how buying this Bond in todays market will work out for the cash rich bottom fisher (or Government).

Purchase price of the $20 million Bond at 50% of book value = $10 million.

Note: This is way above the prices paid on the 1st Lehman Bro’s sales of similar assets.

Interest income is unchanged at $100,000 per month. The interest rate though is now 12% based on the $10 million invested.

Finally, let’s suppose our government is the the buyer, and they have promised to do everthing possible to help the 7% of homeowners who are struggling. Given a 12% effective rate on each mortgage they have plenty of scope to re-negotiate the loan into a much lower rate at which many troubled borrowers will be able to save their house.

Remember, Uncle Sam can borrow easily at rates less than half of that which will be earned. If the Treasury borrows $10 million at 5% and is able to earn 12% on it, and therefore help prevent large numbers of foreclosure, then I’m all for it..

This is a pretty simplistic example but hopefully the big big picture is clear.

As always comment are welcome.