Skip to comments.Some mortgage meltdown math
Posted on 09/29/2008 7:20:29 PM PDT by PhilosopherStones
Current value of mortgages in the US: $12 trillion
Current 90 day late/default rate (all loan types, sub-prime/Alt-A, jumbo, prime): 4%
Current exposure: $480 Billion
Hypothesis: 90 day late/default rate doubles.
Hypothetical 90 day late/default: 8%
Hypothetical exposure: $960 Billion
Hypothetical value of underlying Real Estate (based on worst-case as in CA Central Valley, Las Vegas, Florida): 60%
Total exposure risk: $576 Billion.
That's it folks. If (worst case) defaults double and the underlying assets sell for only 60% of their original selling price, our total exposure is less than the "bailout" amount.
Now all the housing experts can flame away!
Problem is we have become an incredibly risk averse country. We want government to help us out of every little bump and scrape.
No flame from me (25 years in mortgage banking). Sounds like you may have overstated the worst case scenario.
So let’s start selling the bad debt now. Why don’t the banks want to do this? Locally banks are getting bids of 70 cents on the dollar or so for foreclosed houses and won’t sell — there was a piece on local TV last night. Why not? Waiting for the bailout to make them whole I would bet.
Do you have any idea what is going on at the banks holding the mortgages?
What...you mean that prices come down to where they should be? Making them more affordable?
Gee..letting the market work...what a concept!
The big problem isn’t the underlying mortgage values. The big problem is the Credit Default Swaps that were written on top of it all.
Sure! Nothing like taxing someone who doesn't own a home...to provide a bailout that props up home prices artificially even more!
For point of reference, $1.3 TRILLION of market wealth was wiped out today in the U.S. alone. Over $3 TRILLION globally.
Is the exposure the DIFFERENCE between the loan amounts and the asset values? In this case $384 billion?
That home I said used to sell for $435,000 and was listed at $260,000. It is now at $134,000.
What do the banks do with the houses. Just give them away?
What is the estimated value of the worthless credit default swaps on these estimated defaulted mortgages? How does that affect the situation?
As I’ve posted elsewhere, MBS derivative risk is a convergent series (toward zero) because any deravtive will have LESS risk than the original obligation. And given the premium for off-setting the risk, the derivative risk is generally substantially less.
So first order derivatives are less risky than the original.
Second order derivatives less risky than the first order, etc.
Second, include the market-based insurance program which was part of the plan.
Third, realize the bailout is initially only $250B, not $700B.
Combine mark to market elimination, the private insurance program, and the phase one $250B on the CDO market, and estimate the stabilization effects of those actions.
Compare to your $576B.
As I understand it, although the bad mortgages are the underlying cause of the financial problem, it is the derivaties that these banks/investment institutions bought and sold that is the driving force for the meltdown.
The flip side of the coin is the psychological part. It appears that banks are not lending money until they understand where they are with respect to their own assets. How to deal with that?
How do you replace that kind of money in the economy?
There isn't really anyone left to borrow from. Just printing up the money creates other huge problems.
If we don't recapitalize the markets soon, the entire economy grinds to a screeching halt. I've never been an alarmist before, but this is the most serious financial crisis I have ever seen in my lifetime.
I think someone is blowing smoke 3:1 spread is a lot. My wife is an inactive Realtor, houses don’t price this way for no reason. There are 16,000 houses up the road, that are on the books as foreclosed. None have this sort of swing. Most are 20-30% drop. Some maybe 50% if they are in a bad location. Average price in our area is down 27% or so.
What do you think is up with that? Someone just got taken in the bubble? But then why did the bank finance, don’ they know about appraisers?
Unless — Could be just an outlier, bank desperate, I do know of rings of bad apples that were flipping homes that just got indicted, so ... We had local waterfront homes that were priced double what they should have been, but those were speculators.
“Is the exposure the DIFFERENCE between the loan amounts and the asset values? In this case $384 billion?”
The exposure also includes the securities that are derived from the original debt, very leveraged, multiple of 12-30 times the original debt exposure.
Here’s my math:
$12 trillion in mortgages
5% in trouble = $600 billion
95% are performing and banks are making, say, 5.25% PER YEAR in interest on the outstanding principal = $598.5 billion in interest revenue made EACH YEAR by the lenders.
Difference = $1.5 billion
They leant the money. They charge interest to cover their risk. The interest made in one year completely covers their losses if the 5% of bad mortgages are utter losses.
Interesting. Once foreclosed, the asset is the house, not the mortgage. There is no mortgage anymore.
"Waiting for the bailout to make them whole I would bet."
There is no provision in the bailout for foreclosed houses. Of course, if credit loosened up, there would be more demand for the house and the price would increase.
70 cents on the dollar is a bargain. Housing prices have declined by 20 percent. Add in the foreclosure costs, and the bank would be making money at 60 cents on the dollar.
That’s why I posted the hypothetical doubling.
Most of the sub-primes are already out of the system.
Next up is Alt-A (No doc, but good credit rating).
After that will be prime.
At each level, we get a greater percentage of the total US mortgage market, but a lower percentage of defaults (Primes had their ability to repay checked and, generally, were smarter about the types of loans they took).
When the cost of carrying them exceeds the market price of the house, then yes.
The entire credit default swap market is over $60 trillion.
I don’t know how much of that is on mortgages.
Not an expert, but didn’t this bill also put us on tap for failing debt riddled municipalities and cities and towns? I was kinda scared there for a minute I’d have to help bail out Detroit and Chicago, Cleveland, Providence, LA, New Orleans (oh, wait I did that one already)...and maybe the slums of Brazil, oh, yeah and Kenya...and maybe cities under the ocean, Barney Frank’s bath-house and all of Hyde Park, Frankfurt, Bin Laden’s cave network, as well as every roadside attraction, tennis court and shabby Dentist office in America. I was going to help a beekeeper in Muncie, too (Page 77 of the Bill) So I was a bit worried.
If 8% of the $12 Trillion worth of mortgages in the US go into foreclosure and are sold at 60% of the original loan value, lenders will be on the hook for $576 Billion.
That’s what I meant.
Thane_Banquo: “Problem is we have become an incredibly risk averse country.”
Definitely! That’s the same thought process that said the war was lost after we’d suffered 5000 casualties. Unfortunately, our political class is very adept at feeding on our fears in order to stay in power.
You are not including the decline in the value of the collateral asset (i.e., the house).
Mortgage lending at 5.25% APR is a loosing proposition if housing prices are declining by 10% a year.
Have you taken into account the truckload of ARMs and had low initial 3 year to 5 year rates that are about to kick up adjust to the current higher rate.
And what about all the people who have now seen the value of their houses fall below the amount they owe on the mortgage and decide to that they’d rather default and take the credit hit than be pay $300,000+interest for a house that’s only worth $250,000.
And yet the legislation is still in effect to grant high risk loans when the market recovers....
The real exposure is less than that because there are assets and partial income streams behind those mortgages. The problem of course is not mortgages, it would take 100 or 200B at most to fix that. The problem is worthless securities that are NOT mortgage backed, not backed by anything. One example is credit default insurance resold or booked as an asset. It is nothing but a piece of paper. There are many trillions of that.
As I understood it, the banks still have the asset(house) on the books at the full original value. If they depreciate it to what they could sell it for, doesn’t it force a write down at the bank, their assets shrink?
Why else would they not want to sell now, even at a loss. It will be years before prices recover and they have to maintain the property.
We have had a decrease in house prices of about 27% in the local area, but it is starting to tick up.
It’s all the same risk, just parceled out into different forms.
People keep thinking that CDS are some sort of multiplier. They’re not. They just take the same original risk and try to hedge against it.
There is the crux of the problem. The bank lent because it had the money because the mortgage industry was awash in cash because Fannie Mae was guaranteeing all of these crap loans.
Dump money into the system and you get inflation. Economics 101.
Assume 95% of the loans are good, and 5% are bad.
So to model this, take 9.5 ounces of vanilla ice cream, and mix in 1/2 ounce of dog feces. Eat the mixture. Can you taste dog feces? What? You threw up? But it was only 5% dog feces, why did such a small amount make you sick?
gogov: “What do the banks do with the houses. Just give them away?”
It depends. If the bank can afford to hold the house, it might appreciate. They might even be able to rent it until the market turns. On the other hand, they might need to sell it for whatever they can.
Where most people see disaster, I see incredible opportunity. For those who have cash, this might be a one-in-a-lifetime chance to pick up some valuable assets for pennies on the dollar.
I’m talking about the existing mortgages. 95% of them are performing and generating a revenue stream of $600 billion per year for the banks.
That should be the first place we look for bailout funding.
Thanks for the laugh! ;Oh it was funny because it was too true.
It sounds like the fed keeping interest rates so low for so long may have added considerable fuel to the fire. Plenty of people suspected that long ago.
I know we kept getting calls about interest only home loans ... didn’t sound like a good idea to me — LOL.
ARMs generally go into the Alt-A category (which is where we are now after clearing most of the sub-prime).
IF lenders could (or would) refinance, most ARM buyers could get a reasonable 30 year fixed at less than whatever their ARM reset to.
That’s not it. Multiply that ten fold because of derivatives.
Once again, derivatives have LESS risk than the original underlying debt (otherwise why would anyone buy them?).
The only problem with derivatives is that no one wants to put a value on the underlying debt. Once that happens, the derivatives will have a value, and a GREATER value than the underlying mortgages because they (by their very nature) have LESS risk.
Its all the same risk, just parceled out into different forms.
People keep thinking that CDS are some sort of multiplier. Theyre not. They just take the same original risk and try to hedge against it.
I admit I cannot fathom why someone would take out credit default swaps for more than the value of the mortgages. Then I read something articles that suggests it is relating to the subsequent tranching and packaging into derivative securities. For example consider this:
Investors may be forced to settle contracts covering the mortgage giants $1.6 trillion in outstanding debt because the government seizure constitutes a credit event that triggers the payment or delivery of their bonds. The International Swaps and Derivatives Association announced on Monday that it would establish a protocol to facilitate the settlement of CDS trades involving Fannie Mae and Freddie Mac.How does one sort this out?
Let’s just pretend that the CDS are spread equally. 5% of 60 TLN is 3 TRILLION dollars.
THAT is the problem. For the life of me I do not understand why these are allowed.
It does not have to be replaced. It is a paper loss and will recoup over time. Always has, always will. Using those numbers, we are down 5 TLN (15 TLN globally) this year. The market routinely “creates and destroys” 100’s of billions a day. It’s not real wealth until you take it out of the market.
This is a good analysis for outstanding mortgage debt.
One reason the proposed bailout is so much larger than calculated here is because only a percentage of the toxic debt they want us to buy is mortgages.
This isn’t about covering bad mortgages - it is about restoring the lender’s original investment in all kinds of bad debt. Paulson wants to give the lenders liquidity (cash) so they can get back to buying/selling debt. Right now their working capital is tied up in bad debts that will never return their investment, let alone give them a profit.
A very big percentage of the trash debt they want us to buy is bad consumer debt - uncollectible credit card charges, unpaid student loans, car loans, signature loans, etc. Very little of this debt is backed by any kind of collateral. Maybe some of the car loans but usually they only return 20% - 30% on the dollar, when and if you can locate and reposess the vehicle.
And we are not going to get a package of mortgages with only a potential 4% or 5% bad home loans.
The packages we get will have some mortgages mixed in with other debt but almost all will be bad - already foreclosed or far in arrears and they will mostly be undersecured.
Remember - part of the original problem is that lenders assigned unearned and false high credit ratings to unquialified lenders.
So some mortgages were made to lenders with poor credit but the mortgage contract shows they have a good or fairly high credit rating. Another reason why no one really knows what is in these packages.
Here is the way it works. A lender takes a big chunk of low rated and bad debt - say $95 million - and adds just enough higher rated debt, maybe $5 million in up to date mortgages, to bump the whole package rating up enough so they can raise the sell price.
The next buyer buys five packages like that and adjusts the ratio of good debt and bad debt to justify an even higher selling price, and so on.
It ends up that no one really knows what they have bought or what it is really worth. The want the cash flow and a chance to resell at a profit.
But when borrowers stop making their monthly payments the whole house of cards collapses.
In 2001 there was a huge decrease in the market also. The loss was a paper loss and only became a real loss if you sold at that time.
If you held your position you eventually recovered excepting the Enron, World Com, crap that we had to endure.
This situation is very much like 2001 only with bigger numbers and compounded by the swaps.
It will work out as well but may take longer. I would also point out the loss today while larger in abosolute numbers was smaller on a percentage basis.
Take a deep breath and sit still. If you were really concerned you would have liquidated at least a year ago and taken delivery of gold or silver. Unless you took that action the best thing is to continue to sit still.
“Investors may be forced to settle contracts covering the mortgage giants $1.6 trillion in outstanding debt because the government seizure constitutes a credit event that triggers the payment or delivery of their bonds.”
Uhm... Unintended (or intended) consequences?
Still all the same money despite the “tranches”.
Here’s an example of how it works:
Tranch A gets 80%
Tranch B gets 10% if there’s anything left after Tranch A.
Tranch C gets 4% if there’s anything left after Tranch B.
Tranch D gets 1% if there’s anything left after Tranch C.
So let’s take a hypothetical $1 million dollar home.
If the buyer defaults and the foreclosed house sells for 90% of the lending price, both Tranches A and B get paid. Tranches C and D get hosed.
If the foreclosed house sells for 80% or less, all Tranches but A get hosed.
But buyers who bought Tranches B, C, and D payed relatively little given ungodly risk that they took in buying in these tranches in the first place.
The problem isn’t just with the amount of money. Frankly, that’s the last thing on my mind. The objections I, and a lot of other people, have to the bailout bill are in the realm of unconstitutional executive power. The money’s just the most visible problem of this bill.
It’s good to see a big government program voted down for once, though, even if just for a day.