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Some mortgage meltdown math
09/28/2008 | PhilosopherStones

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!


TOPICS: Business/Economy; News/Current Events; Your Opinion/Questions
KEYWORDS: 110th; bailout
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To: PhilosopherStones
I do believe that the government has a role in the solution to this mess, but only because there is already a role model for the insurance plan in the federal system, the FDIC (give credit where credit is due). The Federal government cannot, however, bankroll the recovery like this bailout bill proposed. The American free market is the only economic engine in the history of the world capable of dealing with this soon-to-be worldwide financial crisis. I'm not saying we'll have to bail out the world, but it is absolutely vital we show the rest of the world how to do it without resorting to government. Government can provide the framework and the infrastructure for a solution, but at all costs, including the total collapse of the stock market, we must protect the American free market engine. No matter how bad it gets, we will get out of it if we protect the free market. That means we need to find solutions that cycle money back around in our economy without going through the government first.

The FDIC is a good intermediary between private and public realms, at least as far as I understand the system. Beyond that, however, all efforts should be focused on keeping government out of this process as much as possible, excepting where regulations need to be rewritten or removed (Sarbane-Oxley, taxes, etc.).

And keep this in mind. This is a practice run for how to deal with a massive financial crisis. We need to pay close attention to learn from any victories and mistakes here; for in the coming decades we'll have to deal with Social Security.

81 posted on 09/29/2008 9:58:53 PM PDT by y2gordo
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To: Tarpon
I think someone is blowing smoke 3:1 spread is a lot.

Friend just picked up a house for $100,000 last week. Closed on escrow on another for $127,000 four weeks ago. Both houses new, all the amenities. The one at $127,000 has pool, spa, tile floor throughout, granite, all new appliances, three year old house. 2,200 sq ft. Tile roof, modern construction. View lot.

What would be the motivation for blowing smoke (making up these numbers)?

A house we were going to offer on at $260,000 less that six months ago would have been a big mistake at that price and it seemed like a steal then. It has the most spectacular view of the city lights, big house, pool, spa, big yard, great potential. Now it is worth $150,000 to $160,000. At the top of the market it was $450,000+

82 posted on 09/29/2008 10:08:24 PM PDT by gogov
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To: CitizenUSA
It depends. If the bank can afford to hold the house, it might appreciate.

Housing market is not coming back for a minimum of two years. It will be that long before we see the "last of the repos" on the market.

83 posted on 09/29/2008 10:11:10 PM PDT by gogov
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To: PhilosopherStones

1- I was referring to illiquidity of mortgage-backed securities. The Fed is making loans to banks, but that doesn’t help their capital impairment problem.

2- You missed the point about the “digested” loan writeoffs having already caused capital impairment.

3- I don’t disagree with your finger-pointing on blame and as everybody knows the ratings were downgraded, but it has nothing to do with the point I made.

4- The truth is, there is no single amount that can be ascertained as the precise fix. The bailout plan itself depended as much on indirect effects in putting a floor on the value of the securities and encouraging trading activity generally in this market as it did on the direct effect of exchanging those particular assets for cash.

5- The question of whether an individual bank is or is not taking what you or others might consider to be a smarter approach to its defaults on its particular portfolio of credit card debt is not a central question in the crisis.

6- You are absolutely correct in the importance of psychology as a factor in the situation. A number of alternatives might work. The House Republican insurance scheme could be made to work. One economist has suggested rights offerings by the undercapitalized banks backstopped by the US government.

One thing someone might take from your original post is that the problem is least costly if tackled from the bottom of the pyramid, at the individual mortgage loan level, rather than farther up the pyramid at the level of banks’ holdings of mortgage-backed securities. To my mind that is clearly correct, but would require a much larger government bureaucracy and a more profound interference in the markets.


84 posted on 09/29/2008 10:13:42 PM PDT by SirJohnBarleycorn
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To: misanthrope

Thank-you for the kind words. Some currencies, such as kind words, will always retain their value.


85 posted on 09/29/2008 10:19:21 PM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: ThePythonicCow
Essentially, cheap mortgages, mortgage backed securities (MBS) layered thereon, and these CDS's layered on the MBS's, are the inflation that got us out of the crash at the end of the dot-com bubble.

Rather than directly inflate the currency that we were all tracking, we inflated these hidden financial instruments, and took advantage of the inherent lowering of prices for many goods thanks to newly industrialing nations (China) coming on line to hide this inflation.

We are now in a very volatile period, in which the money masters are trying to combat the enormous deflationary forces of this collapsing junk with an awe inspiring, but so far not yet adequate, increase in U.S.Treasuries.

We don't need to expand Treasuries one-for-one to match the collapsing CDS's -- thank heavens. That would mean somewhere between $50 and $100 Trillion, which is too big a number even for Paulson to dare ask for.

But we would need Treasuries of stable value in quantities of a few Trillion dollars, increasing our national debt from, very rough estimate, $10 Trillion to $15 Trillion. Holding the value of Treasuries anywhere close to par value, when this many new ones are printed, will be difficult. I am making my investments assuming a strong rise in U.S.Treasury interest rates over the next few years, as we saw in the inflationary periods of the 1970's.

If all the major counter parties (the other big nations which hold these Treasuries) decide to play nice, perhaps out of fear, then this might actually be sufficient to avoid collapse of the worlds reserve currency - our dollar.

Essentially the risk of systemic failure of the big banks has been elevated to the risk of systemic failure of the big nations.

In my personal behaviour, I am acting as if the odds favor this triage of the current monetary crisis happening successfully, after one to a few more years of pain and a recession, perhaps quite deep. But such a "successful" outcome is by no means certain. It could get a lot worse.

If, or when, the current international monetary scheme breaks down, it will likely devolve into a major war.

My top bet is that there will be one more big bubble first, in energy (oil, gas, coal, nuclear, solar, wind, geothermal, magic pixie dust, ...)

86 posted on 09/29/2008 11:13:57 PM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: ThePythonicCow
A graph I found, showing the recent rise in CDS's:

87 posted on 09/29/2008 11:37:48 PM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: Nervous Tick
Who owns that paper? For what purpose did they buy it?

Goldman Sachs, hedge funds, etc. They bought it to speculate on MBS defaults. It was obvious to everyone with any common sense that the structure of these securities would fail when the housing market turned. People here have been talking about that since 2005 or earlier. Those funds bought the securities hoping for a payoff when the underlying MBS or corporate bonds defaulted. It is "mortgage-related" so would be eligible for bailout money. The taxpayers should not be buying up those, but we will.

88 posted on 09/30/2008 4:11:47 AM PDT by palmer (Some third party malcontents don't like Palin because she is a true conservative)
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To: PhilosopherStones; ThePythonicCow
I guess in all this discussion the part I struggle to understand is why someone would purchase CDS beyond the amount of the actual paper they own, especially since one has to present the asset (defaulted bond or mortgage) to get paid. When there is leverage in these instruments it becomes a game of musical chairs with the fraction of guaranteed losers (1-1/L) going up very rapidly with the degree of leverage (L). I cannot think of a single reason to make a periodic premium payment to be in such a rigged game. I just don't see an "up" side for someone who doesn't hold the asset. Where is the payoff for these folks?

Then there is the pertinent question, "why should I bail them out from what appears to be an imprudent decision of epic proportions?" My working class parents repeatedly admonished me during my youth that there were two important truths: "In a free society, there is no law against being a fool", And "a fool suffers his folly."

89 posted on 09/30/2008 4:36:00 AM PDT by RochesterFan
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To: ThePythonicCow
First, I appreciate your comments. This discussion has been helpful for me to refine my thoughts on this problem.

I don't doubt your graph but the information is incomplete without knowing what assets they back. Lenders get CDSs when, for example, a company borrows money to build a new plant or to build an expensive instrument for a customer. That paper is not nearly so toxic as the mortgages from the housing bubble that we have been discussing. To better understand the situation, we need an accompanying plot of CDS value as a function of independently estimated risk. I have not encountered such a plot, have you?

90 posted on 09/30/2008 4:49:05 AM PDT by RochesterFan
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To: gogov

This sounds way too good to be true. At prices like this, it would be an instant sellout around here. Who would take these kinds of losses.

The motive would be to tell your friends you got an incredible deal ... Happens all the time in the real estate business.


91 posted on 09/30/2008 7:01:08 AM PDT by Tarpon (Barrack Obama will ban all the guns he has the votes for ...)
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To: RochesterFan
I've not seen such plots of CDS value vs risk, no.

As I noted in another thread a few days ago, FReeper Guide to the REAL economic problem - Credit Derivatives - Lesson 3 [Post #6], Alan M. Newman in Crosscurrents has some of the best CDS information I've seen, but even there I don't recall seeing this detail.

92 posted on 09/30/2008 8:47:30 AM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: RochesterFan
For a couple of possible reasons:
  1. to hedge some correlated asset they do have risk in, or
  2. as simply a (hopefully) profitable gamble.
Because the alternative sucks worse. That is, deliberately or not, they are blackmailing us. "Pay up, or else your wives and children to the N-th generation go hungry, as a result of the catastrophic collapse of the world economy."
93 posted on 09/30/2008 8:54:06 AM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: IncPen

ping 47

flipping houses on grandiose scale


94 posted on 09/30/2008 9:42:06 AM PDT by Nailbiter
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To: RochesterFan
A major problem with CDS's as currently traded is that they are not openly traded or priced. We don't know who has what. Apparently not even the Fed knows who has what.

I see plausible reports that the Fed was surprised by the CDS counter parties affected by the collapse of Lehman, and that this was a major, if not the major, cause of the market stress these last two weeks.

95 posted on 09/30/2008 10:01:16 AM PDT by ThePythonicCow (By their false faith in Man as God, the left would destroy us. They call this faith change.)
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To: Tarpon

Southern California, Inland Empire. It is true.


96 posted on 09/30/2008 10:02:02 AM PDT by gogov
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To: gogov

More money than brains ...

We have some pockets like this in Florida. People have houses listed at $5 million when they paid $1.5 million ...


97 posted on 09/30/2008 10:14:37 AM PDT by Tarpon (Barrack Obama will ban all the guns he has the votes for ...)
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