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!
You will though.
I have a question (not a flame):
What is the source of the data and does it include mortgages on US properties held by overseas institutions?
Sorry, but this is a country whose population is increasing at around 4-5% per year. Those people will all need places to live.
No house will ever be worth 6 cents on the dollar (unless it burns down or gets destroyed by a hurricane/earthquake/tornado.
And I’m sure you’ve pulled all of your investments and turned all your cash into gold.
If you believe what you say you believe, you’d be better off investing in lead.
Various. Sorry I can’t repost all the links, but I was just busting through them left and right and forgot to note them.
The two solid figures (which you can Google) are $12 Trillion and 4%.
The rest are just hypotheticals anyway. And no, I didn’t see any data on foreign vs domestic holdings.
That’s a logical starting point in the analysis, but there are additional considerations relevant to trying to figure out how precarious the financial system is.
— You noted a snapshot of non-performing loans. But the financial institutions have already been weakened by losses incurred since the beginning of the housing crisis. Imagine blowing up a balloon - that last breath of air that makes the balloon pop may not seem like a lot of air, but the balloon’s capacity to hold air has already been affected by the amount of air put into the balloon before that last breath of air.
— Historical patterns of default rates are not a good guide to the current crisis. Households are more highly leveraged than in past periods of house value stagnation or decline. Many prime loans or Alt-A loans may end up in a similar posture as subprime loans if the borrower has other debt such as home equity loans or credit card debts that leave a high total household debt-to-total asset value ratio. Furthermore, increases in mortgage defaults do not linearly follow house price declines. A decline of another 15% in average house prices in an area from current conditions might trigger, say 40% of the mortgages in the area to go underwater, just to pick numbers. Also, a change in attitudes towards home ownership by flippers and the unknown effect of illegal aliens who have mortgages may mean a higher percentage of people willing to simply walk away from their mortgage debt instead of trying to continue to pay it or work out a payment plan with the lender, compared to the past.
— In creating a mortgage-backed security, a large number of mortgages are pooled. Someone above asked if you mixed 5% of crap into 95% of ice cream, would you still eat it? But that even assumes one knows that the percentage of crappy mortgages is 5%. The unknown percentage of crappy mortgages mixed into trillions of dollars of mortgage-backed securities introduces valuation uncertainty into much of the total amount of the mortgage-backed securities. The problem is compounded because in the MBSs where the first losses are allocated to certain tranches so as to enhance the credit of other tranches, it is unclear whether and to what extent the amount of crappy mortgages is enough to “breach the levee” and affect even formerly AAA-rated tranches. Also, it is impossible to generalize the problem because the extent of the problem may vary with each different mortgage pool. Furthermore, the investors who bought the AAA-rated tranches often have no experience in holding and valuing mortgage-related assets, they bought them solely as a AAA-rated security roughly fungible with non-mortgage-backed AAA-rated securities, increasing their uncertainty as to how to deal with their holdings.
— We are dealing with a dynamic system with feed-back effects. If the government bailout were to work and the economy avoided a serious recession, the amount of total mortgage-related losses that would end up being absorbed by capital in the financial system would be dramatically less than the situation if there was no bailout (or other governmental action as effective as the bailout) and the economy went into a severe recession or worse, with sharply higher unemployment. This is one of the arguments why many believed it was conceivable the government could actually make a profit on the bailout scheme, at the end of the day.
— The concern of bad debt is not limited to residential mortgages. Commercial mortgage debt is of serious concern, as is credit card debt, in terms of potential losses. The residential mortgage problem is thought by many to be a greater problem in terms of effect, so that if pressure can be relieved on this component the financial institutions might have enough resources to weather the problem in the other sectors.
— The uncertainty as to the value of much of the mortgage-backed securities outstanding and the so far institution-by-institution way the crisis has unfolded has left market participants uncertain as to solvency or staying power of potential counterparties in various credit markets. This introduces an additional illiquidity factor, exacerbating the illiquidity premium resulting from the valuation uncertainty. It also makes it extremely difficult for the banks to increase their capital by selling stock to investors, even at what a bank might consider very attractive prices to the investor.
And one could list a number of other relevant factors as well that should be considered if thinking about this problem.
There are tapes being sold in the .35-.45 cents on the dollar range right now. Of course banks are going to hang around and see how much relief their campaign contributions have bought them before they all out fire sale.
I. M. Prudent (IMP) is a low-income homeowner who bought a $110K home with a zero-down mortgage from Sleazy Banker who bundled and sold a derivative tranched as you suggested. IMP defaults and walks away having paid off $10K. The Fed Bailout Bullies (FBB) purchase the remaining debt ($100K) for $25K. The holder of Tranch A gets it all, with a $5K loss and the holders of Tranches B-D get nothing. Everybody updates their balance sheets. The sheets aren't pretty but the 'toxic paper' is resolved.
Now FBB need to either sell the property for (hopefully) more than $25K or end up eating management/security costs until they can. Some of these sell reasonably quickly and FBB recovers their costs and maybe makes a small profit. Others are in depressed areas and are vacant for a long time. Vandals break in and strip out all the copper from IMP's former house. It then becomes a crack house. Finally, FBB decides to cut their losses and bulldoze the house, sell the land for $10K and have lost $50K in other costs for a net loss.
Is this a reasonable way to view the situation?
Your math sounds fine, but as I understand it, the problem comes from the fact that so many of the bad mortages were sold in bundles along with those that are still performing that no one knows for sure where all the bad loans are located and who’s holding them - thus all packages of loans become suspect and no one wants to accept them as collateral - the key to freeing up the market short of the grand schemes being pushed by the politicians would seem to be tracking each mortgage to separate the good from the bad so that values could be set according to the reality of each loan - shouldn’t be too hard with today’s computer technology, maybe that’s why those who want more government control of the economy are pushing to get this deal done so quickly, before a more precise method of valuing the mortgages can be instituted.......
Pretty much, except that the worst excesses (again, California Central Valley, Las Vegas and parts of Florida) weren’t really in depressed areas. They were in areas that were experiencing a major population boom (5 million new Californians in just the last few years).
These people still need a place to live. So investors will scoop up those houses at 60% and rent them out to the former owners.
Heck, here in the Bay Area you can’t find a buildable vacant lot for under $200,000 (I know, because I’ve looked), so even land prices are worth 40% of median home prices here even without a house on them.
Tarpon wrote: “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.”
You ‘da Man, Tarpon!
Waiting for the bailout has created it’s own kind of moral hazard.
Banks will sell the 70 cents on the dollar foreclosures themselves. They will sell the 5 cents on the dollar foreclosures to the Treasury for 40 cents.
That’s part of the reason I posted those numbers. The fact is that the market can’t put a value on these assets, so they’re not marketable (current value = $0). If you can’t sell something, its market value is zero. Put a number on it (even artificially as the Fed/Treasury are trying to do) and all of the sudden everyone can do the math.
My point is that my worst case numbers (call them artificial if you want) are better than Fed/Treasury numbers (which definitely ARE artificial).
We are in a panic situation. I’m simply trying to quantify (if that’s possible) how panicked we should be. Doesn’t help when Fed/Treasury do nothing but say “Be afraid. Be VERY afraid!”
They have become the primary underlying capital of our financial system. They are highly leveraged. When times were good, and housing prices were rising, we gained tens of trillions of dollars of "wealth" on the balance sheets of most banks and other financial institutions. This mostly all happened in the last five years.
Now that real estate prices have gone down, even when they were down just a modest amount, this leveraging started working in reverse. Most banks and financial institutions, as well as some companies (GE, GM, Ford, ...), the GSE's, and many municipalities, states and our federal government are profoundly bankrupt.
The risk to the value of the underlying assets, our real estate, does not change; you're right on that. But three other ruinous things happen.
The other essential problem of CDS's, since they are not openly marketed and thus transparently priced (no one knows what they are worth), and since they became the absolutely dominant form of nominal wealth, is that they made the very foundation of our "money" supply non-transparent and untrustworthy.
The sterling, and then the dollar were once based in gold. Then the dollar became based on U.S.Treasuries, and the reliable income stream (from our IRS tax collections) for paying the interest. Both those formed an adequately solid basis for a currency. The essential property of any currency is that people can trust it as a store for value.
The world's reserve currency, the dollar (as well as the Euro) is now based on CDS's, which are more systemically corrupt and less transparent than the promises of our politicians.
We are trying to finesse this by bailing out the failing companies, which means replacing their failing paper with U.S.Treasuries. But this requires printing Treasuries far in excess of what the income stream from the IRS tax collections can fund.
The result will be that the value of the failed CDS's do not rise to the value of Treasuries. Rather, the value of Treasuries (and hence the dollar) will fall to the value of the failed CDS's, junk bonds, failed stock, and defaulted mortgages.
Time to stock up on the guns, ammo and whiskey.
It's like those betting on the Kentucky Derby betting, say, $100 million on a race which has total winnings of $10 million. Most of those wagering have no ownership whatsoever of any of the horses running.
This was gambling, plain and simple.
Once the feedback loop of "gamble, lose, suffer" is removed as a throttle of human greed, the limits of greed and excess gambling are only those of our computers -- how many digits can they calculate in their numbers.
Well thought out post to which I must reply point by point:
1) The problem is not liquidity, it’s velocity. The Fed is pumping money into the economy but the banks are sitting on it. If people could get loans they’d refinance to be able to make their payments. Mortgage lenders and banks would take their closing costs and pass the mortgages up the chain. Mortgage lenders and banks would then have more money to lend to new homeowners. etc.
2) Sub-primes, for the most part, have already been digested. The ones that were going to fail have failed. We are now entering into the Alt-A portion as longer term ARMs start kicking in. Then will be primes as people who are underwater (negative equity - usually from maxing their equity lines of credit and then watching home prices drop) decide to bail. Each of these two latter groups represent a larger portion of the total mortgage market, but a much smaller risk of default than the sub-primes.
3) Freddie, Fannie, Moody’s and S&P all share blame in first packaging those securities and then rating them AAA. There’s no way they were AAA. Call it your Democrat corruption machine at work. At the end of 2007, the spread between sub-prime and prime loans was down to less than 1%, ignoring the fact that the known default rate spread then was closer to 10%.
4) I’m not against a bailout per se to avoid another great depresson. I’m simply trying to put a number on how large the bailout needs to be. Of course the price we are paying for staying home in 2006 is that the Dhimmi controlled congress who caused the problem in the first place will end up doing more harm than good.
5) Credit card debt will be a problem, but if banks had some liquidity, they could refinance that debt at current interest rates. Don’t tell me they wouldn’t rather you continue to pay your unsecured debt at 9% (instead of the 25% you may be paying now) rather than have you declare bankruptcy and just walk away.
6) Panic. Panic caused by uncertainty. So pull a number out of the hat and call that the value. Now you need some serious chops to be taken seriously when you do that, but I think that was what Paulson and Bernanke were attempting to do. Give the debt a value. Any value. But make it stick.
Very well done, Sir.
This is one of the more interesting threads I’ve read on FR, and I’ve been here a while.
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