WHY IS BAILOUT SO BIG?

ISRAPUNDIT ^ | Sept 21/08 | Ted Belman

[tedbel]

I was watching FOX News yesterday and one of the reporters said that a Trillion dollar bailout would cost Americans of $3600 each. This seemed like a high figure so I decided to do some research.

The US Accountability Office issued a report last year,

However, as of the latest quarterly data available, June 2007, more than 1 million mortgages were in default or foreclosure, an increase of 50 percent compared with June 2005. [..]

Overall, the number and percentage of mortgages in default or foreclosure rose sharply from the second quarter of 2005 through the second quarter of 2007 to levels at or near historical highs... The overall default rate grew by 29 percent, reaching a point at which just over 1 in every 100 mortgages was in default, almost a 28-year high.

We are now told that 9% of all mortgages are in default. How could this be? In one year the percentage in default rose nine times. All this when the economy is relatively stable and the unemployment rate is high but not that high. Keep in mind that most people with mortgages have been paying on them for over five years. Surely they are not in default.

In August, Bloomberg reports One Third of New Owners Owe More Than House Is Worth

Almost one-third of U.S. homeowners who bought in the last five years now owe more on their mortgages than their properties are worth, according to Zillow.com, an Internet provider of home valuations.

Second-quarter home prices fell 9.9 percent from a year earlier, giving 29 percent of owners negative equity, said Zillow, the Seattle-based service that offers values for more than 80 million homes.

[politicket]

This person isn't taking into account the credit default swaps and other financial instruments in the derivatives market.

I expect the final figure to be at least $2 trillion. It will sink our economy.

[Jo Nuvark]

Savage’s Solution for
the Wall Street Crisis

Cut off all medical, educational, legal and housing benefits to illegal aliens immediately. Deport all illegal immigrants now in jail.

Arrest, indict and try the CEOs and CFOs of Wall Street firms suspected of financial misdeeds.

Seize the assets of CEOs and CFOs when their chicanery is proven. Turn their ill-gotten gains over to the American people.

Fire Chris Cox, the head of the Securities and Exchange Commission, for his criminal negligence in allowing Wall Street to rape the American economy.

Replace him with Eliot Spitzer, who, before he was taken down by the money changers, was the only one going after the criminals on Wall Street.

Stop the Federal Reserve from bailing out multi-billion dollar companies at the taxpayers’ expense.

Fire Ben Bernanke and let him get a job at NYU Film School.

Fire Hank Paulson and let him get a job as a celebrity chef.

[norraad]

I came up with $4000 or $5000 for each taxpayer, what formula are you using?

[babble-on]

Remember, that the huge announcement is not really spending. This isn’t a stimulus package, its a financing package. The actual budget loss will depend on the size of the defaults and the value of the collateral.

So to look at it as a cost of 3600 per household is misleading. It will cost something, but right now its all loans against assets that do have some value.

[tbpiper]

would cost Americans of $3600 each

This is a misleading statement. It implies that every man, women, and child is going to have to cough up $3600. This will give you an idea of the scope of the buyout (assuming that's accurate) or it would be useful in say a far left democrat presidential campaign.

[PhilosopherStones]

Here’s what I’ve been saying on several threads here. While the default rate is very worrying, 91% of mortgages are NOT in default, meaning that the total value of all mortgage back securities (including derivatives) should be discounted around 10% (and not the near 100% that we’re seeing because nobody knows what the real number is).

Fact is that mortgage rates are WAY down, but people can’t refinance because nothing is moving.

Unfreeze the credit system and these people can refinance back down to an affordable level which will bring the default rate down and improve the overall value of the mortgage backed securities.

[LibLieSlayer]

Or it might make the US economy money. You do not know how many bad loans are in these packages and neither does anyone else... but you know doom and gloom pretty well.

LLS

[Doe Eyes]

I expect the final figure to be at least $2 trillion. It will sink our economy.

We've run up the national debt by more than that over the past eight years.

[border bud]

I love your analysis of this. It makes a lot of sense.

[griswold3]

Now you’re making sense! All these figures being bantered around is causing hysteria.

[Cheapskate]

Why is the Bailout so big????

Because all the "Beautiful People" need their cut!

[PhilosopherStones]

Look, derivative risk is a convergent series which converges toward 0 (not that any risk is ever 0).

The purpose of a derivative is to REDUCE risk. No one would pay the overhead on a derivative if it had the SAME risk as the original investment portfolio.

Let’s take an example:

Let’s say that the original portfolio of sub-prime/regular loans had a default risk of 30%.

A first order derivative would probably sell only if the default risk was at or around 20%.

A second order derivative (derivative of the first order derivative) would probably sell only if the default risk was at or around 10%.

Etc.

As you can see, at each step, the risk is reduced, not increased.

The TOTAL risk of the original + derivatives is the integral from Original Risk to Zero. Problem is that we don’t know yet what the original risk is, so we can’t do the math.

[Moonman62]

So to look at it as a cost of 3600 per household is misleading. It will cost something, but right now its all loans against assets that do have some value.

Right. The assets will be bought at a big discount. The government could break even or even make money in the long run. Even a small loss would be a good deal in order to get the financial system unlocked.

[SirJohnBarleycorn]

People who have no idea how the financial markets work are making comments that confuse the issue.

The reason the bailout number is so high (and may get higher) is because the government has decided the solution is to buy impaired mortgage-backed securities and not just the underlying non-performing mortgages.

The way our mortgage-financing system works, to oversimplify a bit, is that large numbers of diverse mortgages are collected into a large pool and a security representing that pool is created and ultimately purchased by institutional investors, such as a pension fund or a mutual fund.

So let’s say a pool has $1000 principal amount of mortgages. If nationally 5% of residential mortgages are non-performing, then if we applied that to our pool there would be $50 out of the $1000 principal amount that is impaired.

However, the uncertainy as to just how many of American home mortgages are or will become non-performing, whether the non-performing part of the $1000 security is the same as the national average or higher or lower, whether any third-party guarantee of the $1000 security (such as a credit default guarantee by AIG) has any value now, and many other factors mean that the market participants are unwilling to say exactly what the value of that $1000 security is. Maybe its 950, maybe its 900, who knows.

Because financial institutions are supposed to value their securities at market value, when the market fails to assign a value, the accountants will often undervalue them on the balance sheet of the financial institution, leading other parties to wonder whether the financial institution holding the security that is hard to value is really in trouble or not.

So the cost to the government of the bailout is the cost of buying that $1000 security, NOT the cost of bailing out the $50 (or $100 or $30 or who knows) of non-performing mortgages that are included in that $1000 pool.

We the taxpayers have to pay $1000, but we will not end up losing that much. Ultimately, if managed properly, at the end of the day we will lose only the value of the underlying bad mortgages, the $50 or $100 or $30 or who knows.

The cheaper way to approach this would be at the bottom of the pyramid - the government steps in and takes over ONLY the underlying non-performing loans at the individual homeowner level. That would require a huge bureaucracy and would be unworkable, but would be magnitudes cheaper than purchasing the face value of securities affected by the underlying bad mortgages.

Also, buying the securities from the financial institutions means that some firms will get overpaid and others underpaid, and there will great incentive by the financial markets to try to influence the price the government will pay for the securities.

[silverleaf]

If you listen to the Dave Ramsey show (which is a show use by people who want to take some ocntorl over their finances. not necessarily representative of all Americans)

Many of the callers who call in are considering foreclosure or being advised by a foreclosure attorney to file foreclosure.

Or are being advised by their cousins Darrell and Darell to file foreclosure.

And why?

a) Because the house has dropped in value (D’oh! Gotta dump the house it's not worth what I paid for it, “I'm a victim”, it's the bank's fault for lending me too much money and the bank's problem))

b) Because they have more bills than income. “my house payment is more than half of my income” (and what other bills do you have? “Well, I owe $30k on student loans, $40K on credit cards and have a $628 dollar payment on my $30K truck loan and the truck's worth $18K...yada yada yada)

Look, I see whole ethos of irresponsibility that has emerged out there. People feel NO obligation to repay their debts. Foreclosure is becoming as common as a unwed pregnancy. No stigma.

[Chaguito]

$300 billion pumped into the credit system last week was swallowed, with only the faintest of belches. And it remained constipated.

[Raycpa]

The amount in default is not the amount that will be lost on the mortgages. For example, a home with 250k mortgage that eventually sells for 200K on foreclosure is a 50k loss - a fraction of the total.

Further, many of these defaults will not result in foreclosure. The terms will be rewritten and the full balance will be paid-only later or at lower rate than original.

[riri]

Look, I see whole ethos of irresponsibility that has emerged out there.

Well, that's exactly it. They went out and bought these mini mansions they couldn't afford with the idea that hey would flip it in a few years and make 50k or whatever. In those two years, the lack of discipline and the inability to keep up with the Joneses made then cash out the "equity" and treat the house like an ATM. Now there is no equity, no cash out, no real ability to pay for what they couldn't afford to begin with. It's a great case to return debtor's prisons.

[kingu]

Right. The assets will be bought at a big discount. The government could break even or even make money in the long run. Even a small loss would be a good deal in order to get the financial system unlocked.

It depends - if Democrats stick their fingers into it, it could go horribly wrong, but if it is treated like a financial transaction, yes, in the long run, it should be a net positive for the budget. Those houses in default will be sold, and likely re-sold, creating income that will be taxed.

I think something else needs to be addressed - I'm sure there's a pretty significant portion of these homeowners who are in default simply because they've been told by the media they /can/ go into foreclosure and the government will bail them out. I'm also sure that a significant portion of those in default are in default due to balloon payments on their loans that came due down the line. I sincerely hope that when the government buys these 'bad' loans they are sure to trim off the 'fat' of the profit that a lot of these bundlers stuck into the loans.

That's the only place I really see us taxpayers taking it in the backside - profiteering on bad loans, inflating the costs, so the government pays them off.