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!
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.
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.
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.
You seem to be assuming this is all about mortgages? Did you read that bail out bill?
I did, and this is way beyond mortgages and this math, while interesting trivia has been irrelevant for a few weeks now.
CORRECTION TO POST 47:
Remember - part of the original problem is that lenders assigned unearned and false high credit ratings to unquialified lenders.
Should read
Remember - part of the original problem is that lenders assigned unearned and false high credit ratings to unqualified BORROWERS.
That’s it in a nutshell.
For some reason, everyone just went through the poppy field and ignored the tech bubble of the 90s and bought into the banking bubble of the 00s. What next? Whatever bubble it is, tulips, Barbies, or Beanie Babies, Americans will suck it up as long as they make quick cash and then whine and squeal about it when they go broke because they were never educated on the basics of finance and economics in high school.
>> 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.
Who owns that paper? For what purpose did they buy it?
And (not to be callous, but to understand better): why do we taxpayers care if the owners of that paper lose money on it? In a macroeconomic sense.
A normal bank takes in 10 dollars from money invested by shareholders and 90 dollars from deposters and loans out 95 dollars with 5 dollars held in reserve.
In other words a bank keeps 5 dollars of equity for every 20 dollars it loans out on the theory that less than 5% of loans will be in default.
So 576 billion in loses means banks that have loans of 11 trillion are insolvent and can not make any new loans.
That’s right ZERO NEW LOANS.
I’m mixed on the subject. The reason we got here in the first place was because of government forcing lenders to lend to people who they knew couldn’t pay it back.
Government caused the problem, so part of me wants to say that government should fix it. The other (smarter) part of me says that government has never fixed anything, so why trust them now.
The perps can burn IMHO, but that is what is wrong with this calculation.
“has been irrelevant for a few weeks now.”
My point is that it shouldn’t be.
If all those "assets" are for sale at the same time, they aren't WORTH 60 cents on the dollar. They may not even be worth 6 cents on the dollar.
These are ALL possible scenarios. Who decides who gets bailed out? Pres. Obama’s Treasury Secretary, with Pelosi/Reid oversight? I can’t sleep.
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