Now this buyer doesn't really have the money to pay for this purchase so he buys on margin. How much is his lender going to provide and at what rate of interest? If this secondary lender charges more than 8% than the buyer of the bundle is a fool.
If this secondary lender charges less than 8% he is the fool, since he his not being compensated for his risk. You can keep bundling and reselling into as big a Ponzi scheme as you wish, but the principal remains the same.
Now the original bundle suffers a partial loss. I said 5-10% default. Does anyone have figures that indicate that the overall mortgage default market is going to exceed this?
Now the secondary lender gets cold feet and calls in the loan. The CBO buyer can't come up with the money - a liquidity problem. He is forced to sell at a loss. He loses money, so does the firm he borrowed from. Were their losses based upon the decline in value of the original mortgage pool?
I think not. So I'm on the side that says it's not a shortage of capital, it's a liquidity problem caused by panic. Are the banks having a real decline in income or are their "losses" just bookkeeping entries as they write down the value of the securities they can't sell or are forced to buy back?
What happens in a few years when these securities go back up in value as the panic passes? Who cleans up?
What am I missing? Policies not Politics ---- Daily Landscape
The problem isn't the CMOs (note my correction to my original comment.) The problem is what happens once derivatives are spun using the CMO as the underlying asset. derivatives have come far from their original use and the risks to the financial system have grown alongside.
society recapitulates botany? ~"When an inner situation is not made conscious, it appears outside as fate." Karl Jung~
- Jake If you only spend 20 minutes of the rest of your life on economics, go spend them here.
This industry is set to crash and burn.
WE don't KNOW that the banks are insolvent (though we think they are) because they will not let us see their books. If we saw their books we THEN would know.
But they are not fools: There is no way they would let us see their books. How bad is it? Based on how rotten their own position is, they are not willing to other banks whose position is likely as bad.
And is that not bad enough for you? What more, really, do you need to know?
If you were a rich foreigner holding dollars, why would you buy into these insolvent banks? Well, your dollars are going to lose value no matter what you do. By buying pieces of the financial system before the dollar loses value, you might--while taking the inevitable loss--acquire control. The Fates are kind.
The people who have bought into these banks have not bought when all shares in the open market (which keeps the balance sheet unchanged. I presume effectively the bank has issued them with new shares, and if they inject enough capital to make the bank barely solvent everything can keep running. We have met the enemy, and he is us — Pogo
So with a 1.5% interest rate, it can still get an 18% return on capital invested. Also, as a lender, you get first dips at being reimbursed so, as long as you don't lend the whole amount, you let the initial investor take the first hit (the whole thing about CDOs was to create more tranches between the traditional "debt" and "equity" tranches, to fine tune risk taking even better - exactly as ChrisCook suggests should be done).
But my point above is that the 5-10% default rate appears optimstic (see separate answer on that) While the amount of capital at risk has not changed (ie the amount that can potentially be lost), the overall amount of money at risk (in a more diluted way, sure) has gone up. In the long run, we're all dead. John Maynard Keynes
exactly as ChrisCook suggests should be done
Bit confused here, Jerome, what do you think I'm saying should be done? "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Which brings me back to my point that the sharing arrangements are not the problem whrn the risk analysis is not done - and backed by credible players (ie banks and bankers doing their job). In the long run, we're all dead. John Maynard Keynes
That's not the issue: the issue is what is the optimal way out?
Debt got us into this position, so how can more debt get us out? ie it cannot be a debt-based solution.
So "Equity" (with no capital repayment) it must be.
Corporations and trusts are both sub-optimal in their complexity and allocation of risk and reward between stakeholders.
Applying Occam's Razor, the simplest form is the best, and there is no simpler mechanism than simply dividing property revenues into proportional shares or "nth's" using "open" corporate forms. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
Debt got us into this position, so how can more debt get us out? ie it cannot be a debt-based solution. So "Equity" (with no capital repayment) it must be.
Any debt not repaid needs to be covered by capital from someone (including that of the lending bank, if necessary, if repayment never happens) In the long run, we're all dead. John Maynard Keynes
Now, you are correct in that there will be some tranches which hold onto a value better than keeping money in a pillowcase. In particular, loans sold a few years ago or more are pretty good. Not only were they sold in an above board manner to people who could qualify for loans in an above board manner, but the houses were valued at a value more realistic than today's and they were 80% loans.
The last few years the 100% loans and the illicit paper fixing to get someone fundable put a dent in the system. And if it were just taking a hit for those percent of foreclosures (suspected to hit more than 2 million additional to the standard in the next two years) perhaps your paper would return to value after the panic.
But the houses were valued too high to begin with, just because of the easy money bubble. The foreclosures are going to force the house value down in every neighborhood, the fact that job loses are going to accelerate will take buyers out of the system which will force house prices down, the fact that only the most pristine buyers will be looked at will take more people out of the system, driving the prices down.
Suddenly, even if you had the truanch based upon the best properties and were able to sit out the panic portion of this problem, the houses in your portfolio are not worth 60% of what they were loaned at. Or worse.
I had a house that I bought in the 80s - put 50K in paint and a new kitchen so that I had 425,000 in it. Market collapsed. Value was at less than 300K for a long time and didn't get up to 425 for a decade. If I had to sell (to follow a job, for example) or if there were a medical disaster (I was self employed, no insurance), that house would have been on the market and someone would have gotten a deal in your long run.
And that is how I think that the best AAA tranche is short term, incalculable dust, and the worst are sand through the fingers...you just can't hold out that long for something that is going to stay undervalued for the length of time it would take to "normalize".
And yet, many American corporations have a lot of cash, and have the ability to tighten up at home and sell more abroad. It will be an interesting game. So, what you are saying rdf about the houses might actually be true about the stock market...some parts might be a disaster, but they are not the majority and there are some parts that are just going to grow fine...though there are a lot of presumptions even in that (like, at which point can they just not afford to keep us old folks alive anymore on the high priced medicines and care that it will take to do so? Never underestimate their intelligence, always underestimate their knowledge.
Frank Delaney ~ Ireland
Problem - this immediately puts many buyers into negative equity, which means the resource against which the loan is secured is now worth much less than the book value.
So even without defaults, any loan secured against property sold during the bubble is going to be worth 75% (generous) to 50% (more likely) of its nominal value.
Once people start defaulting, the negative equity value becomes the likely realisation value. Given the fire sale nature of what's happening, and the dearth of buyers (no new lending, except for those with perfect credit) the realisation value will drop still further by perhaps another 50%.
So my guess is that the actual write-off figure before leveraging is going to be around 40-50% across the entire US mortgage market, including stable older loans.
If unemployment explodes that figure could be even lower, because some of those older loans will turn into defaults too.
Of course, I could mention peak oil and food/energy inflation here, but that would just be depressing, wouldn't it?
