Today’s focus is bank capital.

More added at 1 PM EST, including comments on widespread fraud.The Washington Post reports,

“The problem in the banking system is not one of liquidity, but of a potential shortage of capital,” said Carnegie Mellon economist Marvin Goodfriend.

By that theory, the best thing that can happen would be for banks to raise more money.

There was an example of that Monday when UBS, Europe’s largest bank, said it was raising $11.5 billion from two foreign investors, and mortgage-lender Washington Mutual said it will raise $2.5 billion by issuing convertible stock.

Commentary on Singapore’s rescue of UBS can be found in the Wall Street Journal. More on WAMU’s woes can be found in The New York Times.

I think it’s great the individual banks are shoring up their capital. However, as I’ve said before, I worry that thin markets in asset-backed securities could be forcing banks to sell securities to raise capital. That would create a sort of vicious spiral.

1 PM UPDATE: Tyler Cowen points to James Surowiecki, who writes.

Postponing rate resets doesn’t change the fact that too many people spent far too much borrowed money on houses with prices that were far too high, and that they are now stuck in homes that they can’t really afford and can’t sell.

Sounds like an echo of what I wrote yesterday.

Tyler also points to Mark Thoma who in turn points to a column by Sean Olender.

But unfortunately, the “freeze” is just another fraud – and like the other bailout proposals, it has nothing to do with U.S. house prices, with “working families,” keeping people in their homes or any of that nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value – right now almost 10 times their market worth.

A lot of these mortgages are defaulting within the first twelve months, and I’ve said before that back when I was at Freddie Mac (this was the stone age, when home owners actually had to put money down to buy homes) we presumed that anything that defaulted that early was fraud. It was up to the institution that sold us the loan to prove otherwise.

The difference between Freddie Mac and the typical private packager of mortgages is that Freddie Mac guaranteed investors against loan defaults, regardless of cause. If the loan was originated fraudulently, then that was an issue between Freddie Mac and the originator who sold us the loan. We tried to make lenders repurchase loans if we found fraud. Our loan sellers were representing to us that they had underwritten the loans properly. They were giving us a warranty that the documentation of the loan was accurate. These “reps and warrants” provided our legal basis for forcing repurchase.

Private packagers work differently. But somewhere in the process between loan origination and the owner of the mortgage-backed security, there probably are “reps and warrants” that have been violated. They could be small, technical violations, such as an inappropriate document used to verify income. Or they could be more egregious violations, such as falsifying the name on the loan application. A lot of those violations are from the loan seller to the loan packager, neither of whom currently bears the risk of the loan default.

Further up the food chain, there could be “reps and warrants” about the mortgage pools making up the securities that might provide a basis for legal action. That is, the packagers presumably have to make some “reps and warrants” to investors.

If you are an investor, I assume that the people you want to sue are the packagers, i.e., the companies that bought from the brokers and sold securities. But the problem there is that you are suing them on the basis of what they represented about their entire mortgage pool. It’s not worth going through loan by loan. What you want to do is force them to repurchase the whole pool on the grounds that the violations of reps and warrants were systematic, so that the packager was deceiving investors. I have no idea how easy or hard this would be to prove. I have never looked at the offering circular of a private mortgage pool, so I don’t know what the reps and warrants look like.

UPDATE: My comments on Olender were mild compared with Felix Salmon’s.

But investment banks were just the middlemen, funneling subprime mortgages from originators to investors who were desperate for yield. I don’t see how they should suddenly be forced to buy back all those mortgages at par, and I’m quite sure that they have no legal obligation to do so.

Again, it would help to read the offering circulars to see what rights the investors do and do not have with respect to the investment bankers.