[kenberg]

Suppose a 400K mortgage results in foreclosure and suppose the bank, after all expenses, clears 250K. That's 150K that is simply gone. This, or something on this order, has been widespread. Let's say that X is the sum of all these losses.

My question: Now has the loss of these X dollars been spread around? Who is taking the hit? The banks? The folks who bought these bundled whatever they ares? The government (us or our grandkids) through the bailouts?

I realize that there are many other questions. But this one seems like a good starter.

A follow-up, for Dems, Reps, and Tea-partyers: What is your position on who should take the hit with all the losses so far and those to come?

The question presupposes that the money is truly gone. I believe this to be true. Maybe the housing market will hit bottom somewhere and take a modest bounce back, but the absurd prices on which these mortgages were written were pure fantasy. The money is gone.

[wyman]

 kenberg, on 2010-October-25, 20:42, said:

Suppose a 400K mortgage results in foreclosure and suppose the bank, after all expenses, clears 250K. That's 150K that is simply gone. This, or something on this order, has been widespread. Let's say that X is the sum of all these losses.

My question: Now has the loss of these X dollars been spread around? Who is taking the hit? The banks? The folks who bought these bundled whatever they ares? The government (us or our grandkids) through the bailouts?

I realize that there are many other questions. But this one seems like a good starter.

A follow-up, for Dems, Reps, and Tea-partyers: What is your position on who should take the hit with all the losses so far and those to come?

The question presupposes that the money is truly gone. I believe this to be true. Maybe the housing market will hit bottom somewhere and take a modest bounce back, but the absurd prices on which these mortgages were written were pure fantasy. The money is gone.

1) Not all foreclosures result in losses. In some cases (say a person owes 100k on a 200k loan), the banks are repo-ing houses, slapping on a fresh coat of paint, and selling as new (in our example, for 200k or so). It was the "good ol' days" of foreclosure investing when the banks just wanted to recoop the losses (i.e., you could get the example house for 100k).

2) Banks often package and sell their notes to investors (usually large institutional investors: IBanks, hedge funds, pension funds, mutual funds, etc). The banks discount the notes a bit so the investors are getting a higher yield, but the banks are getting cash in hand. This happens with mortgages, student loans, etc.

3) Whoever owns the note assumes the risk and takes the hit when things fail.

There are lawsuits in the works now by the investors, because banks did their due diligence (often through a 3rd party) but didn't report risk accurately to investors. So bundles of paper that weren't worth much were being sold as if they were worth quite a bit. It appears (and the lawsuit alleges) that serious fraud occurred.

Certainly the banks should take the lion's share of the blame, but investors should do DD also. Hopefully these suits won't result in bailout #2...

[hrothgar]

 wyman, on 2010-October-25, 21:07, said:

1) Not all foreclosures result in losses. In some cases (say a person owes 100k on a 200k loan), the banks are repo-ing houses, slapping on a fresh coat of paint, and selling as new (in our example, for 200k or so). It was the "good ol' days" of foreclosure investing when the banks just wanted to recoop the losses (i.e., you could get the example house for 100k).

2) Banks often package and sell their notes to investors (usually large institutional investors: IBanks, hedge funds, pension funds, mutual funds, etc). The banks discount the notes a bit so the investors are getting a higher yield, but the banks are getting cash in hand. This happens with mortgages, student loans, etc.

3) Whoever owns the note assumes the risk and takes the hit when things fail.

There are lawsuits in the works now by the investors, because banks did their due diligence (often through a 3rd party) but didn't report risk accurately to investors. So bundles of paper that weren't worth much were being sold as if they were worth quite a bit. It appears (and the lawsuit alleges) that serious fraud occurred.

Certainly the banks should take the lion's share of the blame, but investors should do DD also. Hopefully these suits won't result in bailout #2...

This is a nice summation. I would, however, add that large numbers of foreclosures can exert downward pressure on housing prices. This is having all sorts of effects:

A lot of "wealth" is being destroyed. True, this "wealth" only existed on paper, but still it's a very significant change.

Rental prices are being forced up. I recently purchased a condo. In part, I did so in order to build an inflation hedge into my portfolio. (No better inflation hedge than a 30 year fixed mortgage). However, the spike in rental costs was another real consideration. I was able to significantly improve my standard of living without increasing my our of pocket expenses all that much. (on the down side, I'm now exposed in the housing market. Life is gonna suck if prices drop another 30%)

[y66]

I've seen estimates for Fannie Mae and Freddie Mac's part of the tab (the taxpayer part) ranging from $135 billion (cost to-date) to $260 billion and for JP Morgan Chase, Citigroup, Bank of America and Wells Fargo ranging from $27 billion (likely) to $180 billion (worst case scenario). How much commercial banks end up paying will depend on how successful they are at challenging ongoing claims that loans they sold into mortgage bond programs failed to meet underwriting requirements.

Let's call it an even $300 bil with taxpayers eating 90 percent.

The 3 to 4 trillion shortfall in GDP (relative to potential) for the 5 years between 2009 and 2013 due to the depressed economy is probably more evenly split.

[kenberg]

The note bellow was written before seeing the response from Y66. His note contains a start on the sort of factual info I have in mind.

Sure, not all foreclosures result in losses. That is balanced by the fact that some losses exceed 150K. I have come to the realization that one week from an important election there is much talk about anger and very little talk about some very basic facts. Consider:

A bank holds a 400K mortgage. On the books, this is a 400K asset and in fact represents 400K that was transferred, in real dollars to someone. It liquidates the mortgage through foreclosure and salvages 250K.It now has this 250K as an asset and there is a real loss of 150K. Total these all up. Some are not losses, some losses are larger, the sum X is, I think huge.

Lawsuits produce a shifting of money, a good portion of it to the lawyers, but do not reduce the number X (actually it increases the loss since the lawyers must be paid).

Now of course there are other losses. The home purchaser has presumably invested at least some money at some point. But I want to concentrate on X. Sample question:

With no bail-out help at all, I believe that a number of banks would have gone, or would go, belly-up. True?

What I am trying to get at is something like this: Instead of all of this anger, what should we actually do with regard to this huge loss of money? Is it the position of some of these angry people that we should do absolutely nothing and if the banks collapse then so be it? Or what?

I once had 10K in MCI stock Without me paying much attention the name was changed to WorldCom and the value rose quickly to 40K and then dropped quickly to 0. Them's the breaks. I should have been paying more attention but I wasn't. That 10K is not coming back, and neither is the money invested in these mortgages. It's a true loss of real money and anger doesn't help. But it would be good to know the approximate value of X, and to know what the suggestion for action is from the vast sea of angry people.

[hotShot]

A lot of people have not realized yet, that they are carrying big parts of the losses.

A lot of those now worthless paper where invented, because there was/is more money looking for interests than the amount of money that can be put in save credits and mortgages.
A significant part of that money is from life insurances and pension plans.

Don't be surprised when you retire, when your pension plan or life insurance did not deliver the expected profits.

If politics would have allowed the banks to go down, they would have taken down some insurances and pension fonds too.
What do you think would happen if a significant amount of citizens would have to discover, that their pensions are gone?

[kenberg]

 hotShot, on 2010-October-26, 06:53, said:

A lot of people have not realized yet, that they are carrying big parts of the losses.

I would extend this. I think a lot of people do not fully realize that the money is gone. Politicians speak of the need to restore the housing market. Sure, and get me my 10K back from WorldCom while you are at it. This will not happen. The first step in getting to any serious policy is to acknowledge that the money is gone. And it's real money. Banks paid out real cash to a seller when the house changed hands, they got a mortgage in return, and this mortgage is now in salvage.
The money is gone, more money will be disappearing in the not so distant future as more foreclosures come up A backlog of half a million foreclosures in Florida, or so I read.

Anger is the easy part. What's the plan?

[phil_20686]

 kenberg, on 2010-October-26, 07:42, said:

I would extend this. I think a lot of people do not fully realize that the money is gone.

Anger is the easy part. What's the plan?

I find it hard to argue with your logic about the money being "gone" but I find it difficult to accept intuitively. Partly this is because I dont think money has any intrinsic value, the house has value, and as long as the house is there its hard to see how wealth has been destroyed. Let us have a wee look at the total system rather than individually. Suppose that $X has been lost from the housing market, then this must(should/may/might be a first order estimate that) mean that houses now are cheaper by a fraction X/Prior total. Thus if I am a first time buyer buying a house now, I get the same house for less money, thus a first time buyer has "profited" from the financial crisis. Now you might say that this money never existed, and that this profit is purely nominal, but it is precisely for that reason that its hard to accept how the banks have lost money - they paid a certain amount for an object, they still own said object, the "loss" is nominal in the same way that the first time buyer's profit is "nominal".

Thus i suppose that either you accept "nominal" value and accept that banks have lost money and new buyers are making a roughly equivalent profit, or you think nominal value has no meaning and you dont accept the "loss".

PS: Perhaps this example makes it clearer what i am getting at, suppose that I buy 5 banannas for $2 on a monday, on tuesday the price of banana's has doubled to $4, does that mean I am $2 richer? Have I created any wealth? To my mind, I have exactly the same "wealth" on tuesday as on monday, but I accept that had I bought bananas on tuesday I would have been 2 dollars poorer. The point is that in order to talk about profit or loss here I need to define a reference value for the "real" price of banana's, and as soon as I do that I must use the same reference for all commodities. Say on Wednesday the price of bananna the price of bananas falls to $1, (and I havent eaten any), does that mean that I am poorer on wednesday? or is it more accurate to say those who buy on wednesday are richer? Both make equal sense.

[hrothgar]

 phil_20686, on 2010-October-26, 10:36, said:

Perhaps this example makes it clearer what i am getting at, suppose that I buy 5 banannas for $2 on a monday, on tuesday the price of banana's has doubled to $4, does that mean I am $2 richer? Have I created any wealth? To my mind, I have exactly the same "wealth" on tuesday as on monday, but I accept that had I bought bananas on tuesday I would have been 2 dollars poorer. The point is that in order to talk about profit or loss here I need to define a reference value for the "real" price of banana's, and as soon as I do that I must use the same reference for all commodities. Say on Wednesday the price of bananna the price of bananas falls to $1, (and I havent eaten any), does that mean that I am poorer on wednesday? or is it more accurate to say those who buy on wednesday are richer? Both make equal sense.

Back in the weird old days, when I taught economics to eager young minds, the intro macro classes explained that fiat money served a number of different purposes.

Money is a medium of exchange
Money is a unit of account
Money is a store of value

You're focusing on the the first two line items. Its when you add the third component to the mix where things start getting interesting.

Let's assume that (overnight) the price of all goods and services were to double...
The price of bananas doubled, as would your paycheck, as would everything else...

Would this have any impact on the economy?

The answer is a resounding yes.

Borrowers would make out like bandits because the real value of their debt has been cut in half.
Lenders get destroyed, as do individuals foolish enough to be holding actual dollars.

Now, lets consider your case, where the price of bananas suddenly doubled however all other prices stayed the same.
People who are holding bananas are suddenly very happy. They can make themselves better off by selling some of their bananas and using the funds to buy other goods and services.

Or, in a world where housing prices are going up, up, up they can borrow against the increased value of their house with a second mortgage and use the money to fund consumption.

[kenberg]

The banana example applies to me, not to the banks. I can give an actual example.

We moved four years ago when houses were overpriced. We had no mortgage on the house we sold and, except for a very temporary mortgage of convenience, we took out no mortgage on the comparably priced house that we bought, and so the inflated prices had little consequence for us. Our house was valued at "one house", we had little concern as to how that translated into dollars. If we were to move again we could not sell this house for what we paid for it, but if we were still living in the house we sold we could not now get what we got for it then either.

For the banks it is, I believe, quite different. It is much closer to my WorldCom example. When the mortgage was written, they paid out actual cash. In return they had an asset, they were the mortgage holders, and the books balanced. Now they are not getting payments and they foreclose. They get some cash, but less cash than the face value of the mortgage. This is a true loss of cash. With my hypothetical 400K example they forked over 400K in cash, got a mortgage, now do not have either the mortgage or the 400K, they have 250K. The money did not exactly vanish, the person who sold the house got it. In my very real experience we could have sold the house four years ago, gone on an extended trip to, say Italy, and now returned and bought a house for much less than we paid then. We didn't do that, but the people who we bought from were an older couple (I'm 71 so older is really older) and they moved into some retirement type place for quite a bit less I think, and pocketed the rest of the cash. That's where the money went. Out from the banks, into the hands of sellers who traded down. Or it went to investors who sold short, we had a thread on "The Big Short" a while back.

If you buy bananas and eat them, their future price is irrelevant. If you own a house and live in it, you care little about the rise and fall of prices. If you write a mortgage for 400K, if the buyer stops paying, if you foreclose and salvage 250K, you are out some money. Money in the sense of cash, not accounting fictions.


I think it worthwhile to understand the size of the loss so far and the anticipated future loss. I think anger is pointless, and I think talk of restoring housing prices is either nuts or intentional pandering. If the banks are to absorb the entire loss I think they may go bust, if "the people" are to absorb it because we have to in order to save the system then we have a considerable right to impose some severe terms on how this is going to work. As I understand it, the bail-outs, as opposed to the stimulus, have worked pretty well. But we are far from out of the woods.

At any rate, I find it most distressing that the main issue as we go to election day seems to be how angry everyone is. This can lead to some very bad decisions.

[Winstonm]

Money is literally borrowed into existence. Wealth is the value of debt, not money. When a foreclosure occurs coupled with a loss in home value, the bank (or whoever owns the note) is stuck with a piece of paper that may say it is worth $500K (the mortgage amount) but no one will pay more than say, $250K to buy the property. That $500K note is accounted by the bank as an asset. When it is only worth $250K, there is a loss to assets. To exist, banks must borrow against assets. Borrow short, lend long. This is the bank model. Banks are dependent upon their ability to borrow to exist.

The other problem occurs with MBS. When a bundle of mortgages is tied to a bondlike structure where all the loans are subprime, and the LTV runs around 95%, and house prices drop by 50%, the MBS that was suddenly worth 92 cents on the dollar is only being bid at 40 cents on the dollar. When you are using the value of the MBS as collateral against loans, margin calls go out when the bond value plummets. When the calls go out, it adds to the fire by increasing supply just when demand is falling.

All hell breaks loose and suddenly the assets you hold that yesterday were worth billions today must be counted in millions.

This is where Bernanke and Co. found themselves on a global scale.

[mike777]

the forum posters have explained why lending money for 30 years at a fixed rate in a nonrecouse loan(borrow can walk away) is a very very risky business.

See Its a Wonderful Life

[mike777]

As for the whole cdo issue keep in mind:
1) Most if not all of the loans are crap
2) If roughly 15% of the loans default over lifetime of the loans, in the bet, you owe the whole 100M, not 15%.
3) To play this game you pay roughly 1-2M per year in insurance premiums.

[kenberg]

Mike, I was hoping to hear from you on this. How loans should be made in the future, and how banks should be regulated, and other such questions, are all important (and probably complex) but I am hoping you will comment on the immediate problem: While some foreclosures may enable banks to recoup their investment (mostly, I imagine, when the mortgage is, say,ten years old) the cumulative effect of all of the recent foreclosures and pending foreclosures must represent a very large loss of money. Loss to exactly whom I am not sure, but it certainly seems to me that the loss is very real, not just some accounting matter. I don't listen to Fox news (I am not a masochist), I wouldn't recognize Glen Beck if I saw him, but we have all heard that the electorate is "really angry". OK, I can do anger. But we still have to decide how to deal with this huge loss of actual cash. I get the idea that many candidates are running on a platform that the government should do nothing whatsoever and let nature take its course. Sounds scary to me. What are your thoughts?

[wyman]

Ken,

You keep asking to whom this money is lost. The money is lost by the bank sometimes, in which case it's lost to the home-sellers. This much should be clear. In other cases, investors bought bundles of loans from the banks, in which case the investors are the losers of their actual capital to both the banks and the home-sellers (indirectly).

Since home estimates are based in no small part on recent sale data, foreclosures and the overall dropping of home prices is having a snowball effect. Effectively, the general population is losing money, but this is money that existed only on paper in some cases. It could be that they bought high and are now not in a position to sell (in which case the value has been lost to the home-seller, effectively). Or it could be that they lost the value that paper had showed that they gained: buy at 100k, "value" rises to 200k, "value" sinks to 150k. In this case, the homeowner has lost money only in opportunity.

All of us are losing money in that a large chunk of tax revenue is going to boost the banks back up. On the other hand, it's to everyone's benefit (I suppose this point is arguable, but I'll put an "IMO" caveat) to have banks actively lending to individuals and businesses. Not to mention, banks folding is actually worse for consumer confidence than having to "bail out" the banks, it would seem. Of course, now the wave of class action suits being brought by investors who were deliberately and fraudulently (allegedly, lol) by the banks is going to really shake things up. There can't possibly be enough money to pay these people off. It's going to be real bad.

As to what we can do, regulation would have helped this, as well as people not being greedy a-holes. Regulation is good, but I worry about leaving such things up to congress. And as for keeping people from being greedy a-holes, lol if our government can figure that out.

Letting nature take its course actually sounds reasonable to me. I don't mind seeing banks fail, because new banks will spring up; of course, I don't have enough money in the bank to worry about reaching the limits of my FDIC/NCUA coverage, and I imagine most people don't (it's at $250k now, and if you have that much liquid, it should really be in other vehicles IYAM). Consumer confidence will be shaken, and it will later be restored. That's how things work. We are a forgetful people, even if it takes time. Maybe letting nature take its course doesn't sound incredibly appealing. In China, people would have been executed over this. Does that sound any better?

[phil_20686]

 kenberg, on 2010-October-26, 11:56, said:

For the banks it is, I believe, quite different. It is much closer to my WorldCom example. When the mortgage was written, they paid out actual cash. In return they had an asset, they were the mortgage holders, and the books balanced. Now they are not getting payments and they foreclose. They get some cash, but less cash than the face value of the mortgage. This is a true loss of cash. With my hypothetical 400K example they forked over 400K in cash, got a mortgage, now do not have either the mortgage or the 400K, they have 250K. The money did not exactly vanish, the person who sold the house got it. In my very real experience we could have sold the house four years ago, gone on an extended trip to, say Italy, and now returned and bought a house for much less than we paid then. We didn't do that, but the people who we bought from were an older couple (I'm 71 so older is really older) and they moved into some retirement type place for quite a bit less I think, and pocketed the rest of the cash. That's where the money went. Out from the banks, into the hands of sellers who traded down. Or it went to investors who sold short, we had a thread on "The Big Short" a while back.

But my point is that in your example the bank has lost money 150K by selling the house, but the person who buys the house has "gained" 150K, since prior to the crash he would have had to pay 400K for such a house. If you wish to use the pre crash value of the house for the banks valuation, you must also use it for the buyers valuation. Right?

In this way I find it hard to beleive the money has been "lost" the value represented by that money has been transferred from the bank (or the seller or both) to the buyer. Correct?

[Bbradley62]

 phil_20686, on 2010-October-27, 08:01, said:

In this way I find it hard to beleive the money has been "lost" the value represented by that money has been transferred from the bank (or the seller or both) to the buyer. Correct?

No, the money is actually lost, just as it would be if you invested in the stock market. If you buy $300K of stock and the company does poorly, and you sell your stock for $200K, you have lost $100K. Similarly, if you buy a house for $300K and sell it for $200K, you have lost $100K; the buyer has an asset worth $200K, not $300K, so the other $100K is simply gone.

Edit: If you buy a house for $200K and sell it for $300K, you have made $100K, but that doesn't mean that someone else lost that money. Same concept in reverse...

[helene_t]

In theory the fact that the market value of a particular house has fallen from 400,000 to 250,000 could reflect a decreased utility of the house. In that case, 150,000 is genuinely lost. Like if I buy a pair of shoes for 100 pounds and next week they go out of fashion and now sell for 50 pounds.

Although this may intuitively seem absurd when applied to houses, I think it is partly true. Housing is a luxury good in the sense that it has a high income elasticity. So when the economy shrinks, the optimal income allocation shifts from luxury expenditure (such as the fictive rent house owners "pay" to themselves) to more basic things like food.

The nature of the loss is a decrease in efficiency of the way society's wealth is invested in real assets. Consider a farmer who has a stock of hay and a stock of chicken food, which is an optimal allocation of his stock capacity as he has both some goats and some chicken. Now for some reason he looses his goats and get more chicken instead. Now his hay is worthless to him and the decrease in value of his hay represents a real loss.

I concede that this is only a part (maybe a small part) of the picture. House prices also rise and fall due to changing expectations w.r.t. their future prices.

[phil_20686]

 Bbradley62, on 2010-October-27, 08:15, said:

No, the money is actually lost, just as it would be if you invested in the stock market. If you buy $300K of stock and the company does poorly, and you sell your stock for $200K, you have lost $100K.
Edit: If you buy a house for $200K and sell it for $300K, you have made $100K, but that doesn't mean that someone else lost that money. Same concept in reverse...

I don't dispute that *I* have made/lost money, I merely dispute whether it is lost from the *system* as a whole. After all, in your stock market when I bought it I gave $300k to someone, so how can I argue that the *system* has lost money? Seems to me that this is merely an example of money sloshing around from one investor to another. If you had not bought the stock the original investor may have had to keep it until it was worth 200k, and then he would have lost 100k, so really your loss is his gain, and the system stays balanced. I would argue that true loss of value in the stock only occurs when the fundamentals of the company changes, and that "nominal" changes always balance in the system as a whole. I realise that statement is somewhat general and vague but I am having difficulty being precise

 helene_t, on 2010-October-27, 08:23, said:

In theory the fact that the market value of a particular house has fallen from 400,000 to 250,000 could reflect a decreased utility of the house. In that case, 150,000 is genuinely lost. Like if I buy a pair of shoes for 100 pounds and next week they go out of fashion and now sell for 50 pounds.

Although this may intuitively seem absurd when applied to houses, I think it is partly true. Housing is a luxury good in the sense that it has a high income elasticity. So when the economy shrinks, the optimal income allocation shifts from luxury expenditure (such as the fictive rent house owners "pay" to themselves) to more basic things like food.

You have really captured the essence of the problem for me - it does not seem to me that there has been any wholesale change in the utility of housing, and if the change is purely "nominal" then i do not think the "value" has been lost, only transferred from the seller to the buyer. Of course, I am being somewhat absolutist about the existence of value independent of price - many economists doubt that anything has intrinsic value at all, and would say that the value at which something is bought and sold is the only measure of its worth. That old saw about not being able to eat the mona lisa when you are starving. I would generally argue that the truth is somewhere inbetween these two extremes, but it seems to me that housing has a far clearer "absolute value" than most other examples. It seems clear that the utility of a house cannot decrease unless there is a change in the environment or economic prospects.

[kenberg]

I guess I need to learn how to make myself clear. Yes I agree that: If someone loses a house to foreclosure, if the house is now sold to someone else at a lower price, then one person has lost a house, another person has gained one at a lower cost than was previously possible. Good for one, bad for the other.

I intended to address the impact of a large number of foreclosures on the banks and what, if anything, should be done. I thought I was being clear that if a bank loans 400K and holds a 400K mortgage then the books balance. If the bank then terminates that mortgage through foreclosure and recovers 250K then the bank records a 250K loss.

For each foreclosure, calculate the value of the mortgage minus the amount recovered. Sum over all foreclosures for a given time period. Call this X. I believe X, over the last three years, is large. I believe X, over the next two years, will be large. And I believe this is significant.

Notice that X is a number. Interpret it as you will, it remains a number.


My questions are:

1. What is a reasonable estimate of X? Really this is two questions, the X so far, say over the last three years, and also the estimate of X over the next couple of years, as the foreclosures work their way through.

2. If we do nothing, who is stuck with this loss? The banks maybe, but we all have heard of these deals where mortgages were bundled and traded. Also Mike, in his post, speaks of insurance. So I am not sure who really is stuck.

3. This is a follow-up to 2. Should we do nothing?

4. Another follow-up: Is it the position of, say, the tea-party favored candidates that we should do nothing? It seems like a reasonable question to ask before voting them in. And really, we could ask it of every candidate. Tea partyers are not the only one we should quiz on this. They are just the most tempting because they seem to see everything in such simple terms. Government=evil, end of story.

I perhaps am willing to hear the argument that doing nothing is the right course of action but this certainly is not a self-evident fact and I doubt this is our best course. No one suggests that we should step in simply because bankers are really nice guys with families to support, but neither do I think we should rule out the possibility of further intervention simply because we are angry. As near as I can tell, anger seems to be the main basis for supporting anyone, left, right or center, who promises to vote against further intervention. I think I am as possessive about my cash as the next guy but I think a little caution should be advised here in how we express our anger.


As long as a house remains in good shape it has the value of 1 house. I think I said that about my own house. But my point was that all these foreclosures are a financial problem and some thought about the best response is in order.