Re: on the financial meltdown

[David Farber <dave () farber net>]

Begin forwarded message:

From: Andrew Auderieth <andrew () serve com>
Date: October 13, 2008 11:35:30 AM EDT
To: David Farber <dave () farber net>
Subject: Re: [IP] Re:   on the financial meltdown

I am curious, what is the basis that people who walk away will have  
little
hope of ever getting a new morgtage?  I have seen estimates into the  
high
double digits of mortgages that will go into default.  10 years from now
when financial markets have stabilized, credit scores have returned to  
normal,
and stringent lending practices during those 10 have restored a sense  
of calm
why would lenders turn away such a large potential market?

Aside from the potential market size, there will also be a political  
outcry.
Even though many borrowers bit off more than they could chew in the  
past few
years, the current villain are the banks who let these people borrow  
more money
than they could ever be expected to pay back.  And these villains are  
being bailed
out by the tax dollars of the very people walking away from their  
mortgages. So
when they return looking for homes in 10 years with repaired credit  
histories, why
should these bailed out villains prevent them from having another go  
at it just like
the lenders?

Combine the market size and the political noise of a large base, and I  
don't see the
basis for saying people have "only a faint, if any, hope of getting  
another mortgage".


On Mon, Oct 13, 2008 at 11:21:12AM -0400, David Farber wrote:
> Begin forwarded message:
>
> From: Tom Gray <tom_gray_grc () yahoo com>
> Date: October 12, 2008 7:50:16 PM EDT
> To: dave () farber net, tom_gray_grc () yahoo com
> Subject: Re: [IP] on the financial meltdown
>
>
> Prof Farber
>
> The original posting indicates that a great many people will be
> walking away from mortgages on homes where they have negative equity.
> This leads to the question of where these people will live. They have
> middle class salaries and middle class expectations for housing.
> However, they will have ruined their credit with their choice to walk
> away and only a faint, if any, hope of getting another mortgage.
>
> There are not large numbers of middle class level apartment buildings
> with vacancies ready for poor credit risks. The choice for people who
> have negative equity but can finance their payments could be rather
> stark. They can pay off their mortgage or they will be essentially
> homeless.
>
> ===========================
>
> Additionally, if the money that is being created by the government to
> fix the problem merely replaces the money that has vanished with the
> bubble, then no new net money is added to the system. This is not
> inflationary. The problem now is deflation not inflation and that is a
> much worse problem.
>
> Thanks
>
> Tom Gray
>
>
> --- On Mon, 10/13/08, David Farber <dave () farber net> wrote:
>
> > From: David Farber <dave () farber net>
> > Subject: [IP] on the financial meltdown
> > To: "ip" <ip () v2 listbox com>
> > Date: Monday, October 13, 2008, 3:14 AM
> > Since this is so long Mark's reply Mark is an OLD , in
> > time not age,
> > Wall Streeter who was involved with taking Apple public.
> >
> > Dave
> >
> > Date: Sun, 12 Oct 2008 13:00:36 -0400
> > From: Mark Stahlman<newmedia () aol com>
> > Subject: Re: any comment on this?
> >
> > Dave:
> >
> > Andrew is much better on telecom! <g>
> >
> > Clearly "stabilizing" home prices is very
> > important.  In addition,
> > giving those people who are "under-water" on real
> > estate need time to
> > let all this happen.  This is pretty well known and in the
> > headlines.
> >
> > No one -- including the US Treasury -- actually knows what
> > they will
> > do with the $700B.  That's one of the reasons why it
> > was so hard to
> > pass in Congress.
> >
> > We are in a FINANCIAL crisis and will probably be in one
> > for 6-12
> > months.  However, Andrew has failed to illustrate what the
> > ECONOMIC
> > consequences are likely to be.
> >
> > The "problem" is the old rules are gone and new
> > ones haven't been made
> > up yet.  So lots of people are on the sidelines waiting to
> > see what
> > the new rules are going to be.
> >
> > What I'm most interested in is the *permanent* changes
> > in consumer
> > behavior that this will provoke and how that will change
> > the direction
> > of the global economy.  Yes, it's way too soon to know.
> >
> > Mark
> >
> >
> >
> > Begin forwarded message:
> >
> >
> > From: odlyzko () dtc umn edu (Andrew Odlyzko)
> > Date: October 10, 2008 11:24:50 AM PDT
> > To: dewayne () warpspeed com
> > Subject: on the financial meltdown
> >
> >
> > Here is a little economic model that may shed some light on
> > what's happening to the financial system, why
> > Paulson's recent
> > $700 billion plan may very well be the wrong solution, and
> > why
> > the whole problem is very hard to solve.
> >
> > Suppose your Aunt Millie and her husband retired two years
> > ago
> > from their jobs in Palo Alto, and decided to move back to
> > their
> > native Omaha.  They sold their little shack, bought for
> > $50,000
> > many decades ago, for $1 million (two years ago being the
> > peak
> > of the real estate market, and Palo Alto shacks being
> > pretty
> > pricey even now).  Suppose the mortgage had been paid off a
> > long
> > time ago, so she and her husband owned the house outright.
> > Now
> > by traditional measures (prices compared to household
> > incomes,
> > say) that Palo Alto shack might have been worth $500,000
> > (as
> > Palo Alto is a desirable place to live, and there is very
> > little
> > land that can be developed in the vicinity).  But with the
> > runup
> > in real estate prices, it was valued at $1 million two
> > years ago,
> > and she got that price.
> >
> > After paying realtor's commission, capital gains taxes
> > (the home
> > capital gains exclusion only covers $500,000 per couple),
> > etc.,
> > they might be left with $800,000, say, of which they use
> > $300,000
> > to buy a big house in Omaha, and put the remaining $500,000
> > into
> > a CD in a national Bank Too Big to Fail (BTBTF).  Note that
> > realtors and other agents got a large chunk, say $100,000
> > (just
> > to keep to round numbers), and the governments did not do
> > too
> > badly either.
> >
> > Now further let's suppose that your Cousin Jim, not
> > knowing of
> > the relationship to your Aunt Millie, was the person who
> > sold
> > the Omaha house to Aunt Millie, and bought her house in
> > Palo
> > Alto, not knowing of the relationship, and not knowing he
> > was
> > dealing with the same person in both cases.  Say he also
> > owned
> > his Omaha house outright, and of the $300,000 he got, after
> > paying various fees, commissions, moving expenses, etc.,
> > (and
> > this is important, as the real estate bubble enriched many
> > people, not just the homeowners) had $250,000 left, of
> > which
> > he spent $50,000 on some new furniture, and put $200,000
> > down
> > on that $1 million shack of Aunt Millie's in Palo Alto.
> > The
> > remaining $800,000 came from a mortgage from the Bank Too
> > Big
> > to Fail (BTBTF), the bank that has Aunt Millie's
> > $500,000.  Now
> > putting 20% down was absurdly conservative at the peak of
> > the
> > real estate bubble two years ago, but it helps make the
> > model
> > more realistic, in that BTBTF would have had other
> > mortgages as
> > well, some from years ago, which supposedly have a lot of
> > homeowner equity in them.
> >
> > Now the Bank Too Big to Fail (BTBTF) did not keep that
> > $800,000
> > mortgate of Cousin Jim.  It sliced and diced it, and sold
> > it off
> > (after mixing it up with other mortgages) to other
> > institutions.
> > Say there were 4 tranches into which Cousin Jim's
> > mortgage was
> > divided, each for a nominal $200,000, with slice A having
> > first
> > claim on any mortgage payments from Cousin Jim (or from
> > auctioning
> > Cousin Jim's Palo Alto shack if it goes into
> > foreclosure), slice B
> > having second claim, etc.  (This is not a correct
> > representation,
> > that's not how mortgages were packaged, but it has the
> > key elements
> > of that wonderful "distribution of risks to parties
> > able to bear it,
> > and enabling home ownership" machinery that was
> > operating, so let's
> > go with it.)  And then those 4 tranches of Cousin Jim's
> > mortgage
> > went on some wonderful trips, being further sliced and
> > diced, having
> > their grades improved by credit rating agencies, etc.  And
> > suppose
> > that by some miracle all the trenches ended up with BTBTF.
> > But
> > before they came back, perhaps $100,000 had been extracted
> > from
> > them to pay the mortgage brokers, lawyers, Wall Street
> > investment
> > banks, and of course the management of BTBTF, which showed
> > such great
> > brilliance in minimizing risks and maximizing profits for
> > BTBTF's
> > shareholders.  So now BTBTF has again the entire mortgage
> > for $800,000
> > on Cousin Jim's house, but it is probably valued on its
> > books at
> > $900,000, when you get down to it and examine all the
> > financial
> > details.
> >
> > Now suppose that the Bank Too Big to Fail (BTBTF) has on
> > its books
> > just that mortgage to Cousin Jim, valued at $900,000, and
> > standard
> > commercial loans for $1,100,000 to various companies, say a
> > local
> > car dealer, restaurant, etc..  (Yes, $2 million is not
> > enough
> > to make a bank too big to fail, it's not even enough to
> > pay for
> > legal fees to establish a bank, but I am just trying to
> > keep things
> > simple, BTBTF would have closer to $1 trillion on its
> > books, but
> > then Cousin Jim's mortgage would be swamped by all the
> > other accounts.)
> > And suppose that BTBTF has $200,000 in capital, and
> > $1,800,000 in
> > deposits, Aunt Millie's CD for $500,000 included.  By
> > conventional
> > banking standards, that is extremely conservative, 10%
> > capital is
> > just great.  But these are not the usual times.  Real
> > estate prices
> > have come down quite a lot.  Say they are down by 20% in
> > Palo Alto.
> > (I have no idea of what the actual decline has been in Palo
> > Alto.)
> > But that is just what realtors say, the market is pretty
> > much
> > frozen, and if Cousin Jim had to sell his home today, he
> > might
> > have to settle for just $600,000 in a quick sale.  And
> > prices
> > are going further down.  So for the moment Cousin Jim is
> > still
> > paying his mortgage.  He has his job (at least for the
> > moment),
> > and he has hopes that the value of his shack will go back
> > up to
> > to $1 million, or at least not go down below $800,000.  But
> > if
> > it does go down further, and he is rational, he will hand
> > the keys
> > over to the bank.  And then the bank might have to sell
> > Cousin Jim's
> > shack for $600,000, which will leave it with a loss of at
> > least
> > $200,000, and more likely $300,000, if proper accounting is
> > applied
> > to all the financial maneuvers that had taken place.  That
> > will
> > wipe out its capital, and possibly more.  But what if the
> > price
> > the bank can get is even lower?
> >
> > Until recently, the actions of government agencies, both in
> > the
> > U.S. and other countries, seemed to be based on the
> > assumption
> > that there would be only a modest decline in housing
> > prices,
> > and so all they had to do was keep people from panicking.
> > If
> > Palo Alto housing prices only go down 20% from their peak,
> > Cousin Jim will keep paying his mortgage.  Perhaps a few of
> > his neighbors who got 100% mortgages with montly payments
> > that
> > have just reset to levels they can't afford will walk
> > away, but
> > if the effect is small (say BTBTF has only 10% of one of
> > those
> > mortgages, and the total loss on that mortgage is going to
> > be
> > $250,000, then BTBTF will lose $25,000, which is a painful
> > hit
> > to its capital, but not fatal) then nothing serious will
> > happen.
> >
> > But now the general impression in the markets seems to be
> > that
> > the housing price declines are going to be more serious.
> > Suppose
> > that prices go down to levels consistent with historical
> > ratios
> > of house prices to incomes.  (And they could go down below
> > that,
> > of course, historically this ratio has oscillated.  Note
> > that the
> > situation is worse in many countries than in the U.S.,
> > since
> > those countries, including Ireland, had a more severe
> > housing
> > inflation than the U.S. did.  The crisis started in the
> > U.S., but
> > that could be the result of several factors such as (i) our
> > investment
> > banks being the most leveraged, and (ii) our system being
> > the most
> > transparent.)  What would that mean?
> >
> > Over in Omaha, Aunt Millie and her husband might see the
> > value
> > of their $300,000 home go down to $200,000.  (Inflation was
> > generally
> > lower in the Mid-West than in California.)  That is not
> > that much of
> > a problem, since they own that house outright.  They are
> > probably
> > scared about that $500,000 CD at BTBTF, since the amount is
> > over
> > the limit insured by the feds.  In practice, it seems
> > pretty clear
> > that the feds will cover them for the entire amount, as
> > several
> > countries have moved to do.  But in the meantime, they are
> > probably
> > more than a little scared, and less willing to spend,
> > helping push
> > the economy deeper into a recession.
> >
> > But in Palo Alto, if the price of Cousin Jim's shack
> > goes back to
> > the historical trend of $500,000, he will hand the keys to
> > the bank,
> > sooner or later.  (Sooner if the recession kills his job.)
> > So where
> > does that leave BTBTF?  If it gets Cousin Jim's shack
> > and has to sell
> > it, it will likely get only around $400,000 for it.
> >
> > That means BTBTF is effectively bankrupt, since it has only
> > $200,000
> > in capital, and the loss on Cousin Jim's mortgage will
> > be $400,000
> > or $500,000.  Unless Paulson, using taxpayer money,
> > overpays by an
> > absurd amount, there is no way that BTBTF can break even.
> > Yes, if
> > the free-marketer Paulson decides, in his wisdom, that the
> > free market
> > is grossly incorrect, and that the Palo Alto shack is going
> > to be
> > worth $1 million in a couple of years, he might pay
> > $800,000 for
> > the mortgage on Cousin Jim's shack, arrange for it to
> > be rented,
> > and sell it at the proper time for a profit for taxpayers,
> > and great
> > glory for himself.  But any realistic price he pays for
> > Cousin Jim's
> > mortgage, or pieces of it, will still leave BTBTF under
> > water.
> > There is no way that BTBTF management can make the bank
> > healthy
> > enough, unless either (i) real estate prices recover (which
> > is
> > not absurd, rapid inflation, something that
> > "helicopter Ben"
> > Bernanke had talked about in the past, might be resorted to
> > by
> > the government), or (ii) BTBTF management take wild
> > chances, like taking
> > all the cash in the till and wagering it on a roll of the
> > roulette
> > wheel in Las Vegas (basically what the S&L's did in
> > the 1980s,
> > when they were in a similar situation, and put lots of
> > money into
> > crazily speculative investments).
> >
> > Putting actual capital into banks (basically what Swedes
> > did in the
> > early 1990s, and the British are doing now) seems to be the
> > only
> > way to get the financial system moving.  That way
> > management
> > (and unfortunately, since we can't start from scratch,
> > it means
> > pretty much the same management that got our financial
> > system into
> > the current mess) will have incentives to loan money in the
> > traditional ways, that sustain the normal functioning of
> > the
> > economy, and not wager it in a casino.  But the amount of
> > money
> > that would need to be put into banks for this to work will
> > have
> > to be huge.  It would basically have to be enough to cover
> > all
> > the losses on all the loans they have made (which we
> > can't estimate
> > precisely, since we don't know how bad the recession
> > will be, and
> > how many other bombs are going to explode.  This is in a
> > way not
> > all that dissimilar from Paulson paying absurdly high price
> > for
> > Cousin Jim's mortgage, but it would give taxpayers a
> > better chance
> > to recover their money, and provide better incentives for
> > bank
> > managers to behave prudently, yet perform their key
> > function in
> > the economy.
> >
> > Note that the fundamental problem we face is less the
> > $200,000 that
> > the mortgage brokers, lawyers, Wall Street investment
> > banks, and
> > management of BTBTF got out of the Aunt Millie and Cousin
> > Jim
> > transactions.  It is rather the $500,000 that Aunt Millie
> > and
> > her husband got for their shack above what the likely
> > long-term
> > value of that shack is.  They did not do anything wrong,
> > all their actions were perfectly legal and moral.  But they
> > were
> > the beneficiaries of the real estate bubble, and at least
> > in the
> > short run they are likely to escape unscathed, and without
> > any
> > blame attached.  In the long run, of course, they will have
> > to
> > help pay for the cleanup, either through higher taxes, or
> > through
> > inflation.
> >
> > Sorry this is so long, but it seemed about the shortest
> > model
> > that, even though grossly simplified, still showed what
> > seem
> > the essential features of our current crisis.
> > RSS Feed: <http://www.warpspeed.com/wordpress>
> >
> >
> >
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