Subprimes and such

[kenberg]

I realize that this is a global watercooler but then it's also a global economy so maybe this is an ok topic. Let me pose it my way, but everyone is welcome to come at it from the angle of their choice.

 

When I came of age, c1950-60, loans for young people were hard to get. I paid cash for my first car ($175). When I bought a townhouse I of course had a mortgage, but I also paid a premium (Mortgage Insurance) until I built more equity. Now things are easier. You buy a car on credit, you get early reduced rates on mortgages. In theory, this is good. A person just starting out can buy a decent car and can get into his own home. In practice, I'm not so sure. Many young people end up with $20,000 of credit card debt at high interest rates, mortgages they cannot pay and so on.

 

It's not entirely that I was more virtuous about debt when I was young (although I was taught by my father that if you can't pay for it you don't buy it). My virtue was partly enforced since no one was quick to loan money to young people.

 

So: Are we hopelessly off track here? What are we to do? I don't think of myself as scrooge-like but I can't say I am ready to rescue someone who bought a five bedroom house on three acres and now finds he can't afford it.

 

I'm at a loss to even say what I think we should do, let alone how to get it done. Any thoughts?

 

Ken

[Gerben42]

What I don't understand is the banks giving out the loans: They lose when it turns out that people can't repay the money they got from the bank, so they should be more careful.

 

The solution is more intelligent bankers.

 

I was taught by my father that if you can't pay for it you don't buy it

 

I work on the same principle. I recently bought a car, this was my first big investment. But only after I got the corresponding job to be able to finance said car.

[jtfanclub]

In practice, I'm not so sure. Many young people end up with $20,000 of credit card debt at high interest rates, mortgages they cannot pay and so on.

Which really doesn't matter, as far as the young people go. They'll go bankrupt in droves, people will have to lend to them eventually after a few years (because there'll be so many of them), and they'll be just fine. Lots of young people go bankrupt. While the new bankruptcy laws are much harder on them, they'll come out OK.

 

As for people who expected their houses to keep going up in value...wah. It's a market. If you don't expect markets to fall sometimes, then you're an idiot.

 

The real problem here is the secondary markets. Mortgages were considered both 'safe' and 'liquid', so banks and major financial firms invested billions of dollars in them. Now that you can't give them away, these firms are taking gigantic hits. JP Morgan took a ten billion dollar hit, giving them a five billion dollar loss...their first loss ever. Many were hit even worse. There's a real fear that a number of the big firms (Morgan not included) will actually go under, which means no new mortgages from them.

 

At this point, they're talking a freeze on rates for some people, which will actually help the banks a lot more than it will help the people in the houses (who will rack up even more debt in the process). A better solution, in all seriousness, is for the individuals to threaten bankruptcy to get the bank to give you a more reasonable fixed rate that doesn't involve the principal increasing (as it does on a rate freeze).

 

We're talking a serious credit crash here...25% drop in the value of the average house, 5% of the population going bankrupt, easy lending practices vanishing. But this was all smoke and mirrors anyways. As you point out, when you were young, houses weren't that expensive, and there wasn't free credit everywhere. We'll go back to the old way, and while a lot of people will get hurt, we'll survive.

 

Trying to 'fix' it will just make it worse.

[kenberg]

What I don't understand is the banks giving out the loans: They lose when it turns out that people can't repay the money they got from the bank, so they should be more careful.

 

The solution is more intelligent bankers.

For some years I have wondered along these lines, first with credit cards where people that were in way over their heads could still get new ones and then with these mortgages. I think I have sort of an estimate of what happens.

 

In the model we all have in our heads, the loan officer represents the bank and is expected to make sound loans or else the bank loses and the loan officer gets fired. In actuality this is, or so I gather, far from the truth. The loan gets "bundled" (I have no clear idea of what this means), sold to someone, then used to back securities, folks buy shares, and so on. Presumably someone loses money somewhere, and there was this head of one of the investment firms that got fired, assuming a multi-million dollar severance package is called being fired. But the chain from borrower to loan officer to bank to God only knows where is long and obscure and it is not entirely clear that the bank loses anything or that the loan officer gets fired.

 

One simple to state solution, although I doubt it really is one, is to forbid this sort of transfer of responsibility. Make a bad loan or give a credit card to a deadbeat, you are out the cash. I'm sure that it is not that simple (Paulson is a smart guy and has no doubt thought of this and many other things) but I do think that this long chain of responsibility has something to do with the problem.

[sceptic]

I am quite amused by this subject, more intelligent bankers. I don't think so, they are intelligent enough, they dream up ways of marketing credit and debit, so they can cream a huge profit off for themselves, please do not think I am some kind of socialist as I am not.

 

The young are not really to blame, they have been led up the garden path of the quick profit, perhaps no one really taught them the value of money and all they are victims of, are societies leeches, bankers insurance lawyers etc etc the list is quite long.

 

I do not believe we should bail out the banks, the only people that will be saved are the ones with savings, the ones that cant afford the loans are the ones that in the long run would probably benifit from a few banks getting thier just deserts

 

I think you will find that Greed is the problem, not that we need more intelligent bankers (as I said the are probably to smart for thier own good)

[Mbodell]

Many of the "solutions" being proposed aren't real solutions, and the problem isn't really subprime, at least not the US housing problem, it is something much bigger.

 

The real proximate cause of the foreclosure problem is people owe more on their house than the house is worth (otherwise you don't have foreclosures, you have people selling their houses when they can't carry the mortgage or need to move and pocketing the equity not foreclosing). They are upside down on their house. This happens to people who have prime loans and subprime loans. This happens if teaser rates are adjusted, but also explains why the bulk of foreclosures in the US right now are not yet caused by teaser adjustments, but rather by people before teaser rates are adjusted.

 

Basically the home market had an asset class bubble and homes sold in the US for approximately twice their real value. You could fix systemic problem overnight if you just divided the price on all housing in 2 (with massive temporary dislocation) or if you inflated all money by 2 (again with massive temporary dislocation).

 

Of course no one wants to pay that pain, and it looks to me like we are doing a mix of both strategies, although probably a bit more of the latter inflation one (look at the value of the US$).

 

Of course this would be a huge catastrophe if it just ended there. After all, the net liabilities against US houses is likely to be larger than the total value of all US houses if nominal prices only go down another small amount (10-15% or so) and that is in spite of the fact that about 1/3 of US homeowners own their home outright. But the real huge problem is all the secondary markets and derivatives and what not.

 

In many financial markets the derivatives that trade have much larger values and much bigger trades than the underlying resource. Here what could be a few hundred billion dollars of problems in the actual underlying resource could easily multiply to many trillions of dollars. And if it ends up being trillions of dollars of underlying resources who knows what will happen.

 

Many people feel that they are safe because they've used derivatives to hedge various positions, but if the people on the other side of the positions can't pay then even the hedges fall apart and chaos ensues.

[Winstonm]

The problem is multi-layered and vast. There is very little left of what one might call "pristine mortgages", i.e., those where the originating bank still holds the loan.

 

Here is what happened in shorthand version. First, interest rates were lowered and held too low too long by Greenspan. This started the housing bubble. Next, he endorsed the securitization process and the riskier type loans.

 

Home prices rose to unaffordable levels. Banks became mortgage brokers, selling the loans as fast as they could get them done. With no stake in the loss, loan origination became riskier and riskier until anyone who could still breath could get a 100% home loan with no proof of income. All these loans were packaged and sold to the world as bond-like entities. The ratings agencies gave these bonds their AAA blessings based on computer models that did not take into account even a slowdown in housing, much less a fall in housing prices, and it was based on historical default ratios that were unrealistic with the poor quality loans that were being made.

 

Now you have this mess - millions of loans whose collateral backing is falling in value combined with a huge increase in defaults over what was estimated.

 

There is only one cure and that is for home prices to fall 30-40% and for all the bad loans to go belly up - this is the market cure. Unfortunately, it will also probably bring about worldwide recession so is not high on the list of central banks wish lists.

[glen]

... You could fix systemic problem overnight if you just divided the price on all housing in 2 (with massive temporary dislocation) or if you inflated all money by 2 (again with massive temporary dislocation) ...

So they will go with the compromise:

 

decrease the price on all housing by 1/4 (with semi-massive temporary dislocation) and inflate all money by 1.5 (again with semi-massive temporary dislocation) ...

 

So time to search for the semi-massive temporary dislocation methods

[blackshoe]

But this was all smoke and mirrors anyways.

Last time the government tried to "fix" a similar "smoke and mirrors" problem, we had the Great Depression. Our kids and grandkids will probably have to deal with GD II. Hopefully their kids and grandkids won't have to deal with GD III - but I wouldn't bet on it.

[Fluffy]

I never understood why banks lose money when they get a house and some of the loan back, shouldn't the sum of both be higher than the loan?

[P_Marlowe]

I never understood why banks lose money when they get a house and some of the loan back, shouldn't the sum of both be higher than the loan?

No.

 

The bank will sell the house in an forced auction process,

this means, the bank will get only a certain amount of

money for the house.

 

The bank could of course wait with the selling, but this

would imply certain costs for maintenance of the house,

or the condition / vaöue of the house would decline.

 

The market for selling houses is a slow changng market,

because the house cant be transported.

 

With kind regards

Marlowe

[Fluffy]

I that's true isn't it wort it to lose your house and buy it on the auction?

[Gerben42]

If you lose your house you don't have the money to buy it in the auction. But I can imagine it is lucrative for SOMEONE to buy houses this way.

[Al_U_Card]

ALmost 20 yrs ago when my youngest son was about 5 yrs old, I denied him a request to buy something he "wanted", saying that we didnt have enough money to afford it. He then asked me, "Just write a cheque!" I then spent a few minutes explaining the concept and process to him. He was despondant but finally realized what it meant......

 

The key is to not allow the public purse to "subsidize" the "stupid" bankers that run these Ponzi schemes. Good luck with that.....

 

Stop the insanity! Money for value, not money as debt.

[Al_U_Card]

btw shouldnt credit card debt at 20+ % pa count as usury and arent there laws against that? :)

[kenberg]

About giving up your house because the balance on the mortgage exceeds its value: I'm not so sure.

 

Suppose a guy buys a house for $500,000 and there is a 10% drop in value These figures are pretty realistic these days. In a sense, he can save $50,000 by telling the bank to take this house and shove it. But he has to live somewhere. Even at the height (or depth maybe) of mortgage nonsense I don't think people with foreclosures on their records were finding it easy to get a new mortgage. So if he walks away from the house it seems to me that he will be renting. And maybe having trouble getting in to a decent rental place. Further, the bank may have further claims against him if in the future he gets back in the game.

 

Mbodell, above, gives a very interesting summary of the situation but I, with no figures at all to back my opinion, am still a little skeptical that a large number of people who could pay their mortgages are just walking away because their house has dropped in value. No doubt the amounts are an issue. If the mortgage exceeds the value by, say, $200,000 I can imagine that walking away is tempting. For 50K, it doesn't seem so rational. So a question: Is it possible to really tell who walks away because they cannot pay the mortgage and who walks away that could pay it but decides the house is not worth the payments?

 

To throw another thought into the mix: In some ways, the collapse of the housing market is (or at least in some ways could be) a good thing. With houses getting back to realistic prices it might mean that people can afford to get in. They will no longer be able to do it with the so-called creative financing but if they have a sound financial setting then they can get a sensible mortgage on a sensible house that is going for a sensible price. Of course if everyone is out of work from the depression then this optimistic scenario falls flat.

 

I remain confused.

[hotShot]

Banks earn money by giving out loans. The money they want for that service, depends on the risk they take.

If you give a loan to people who probably can't pay it back, you take a big risk, so you take a big fee for the service.

If you buy a car, it looses value over the time. But if you bought a house during the last 50 years, the price of the house was always going up.

So if you gave someone a mortgage covering 60% of what the house was worth at that time, you could expect that even if the customer only paid the interest and no repayment about 10 years later the house would be worth more and the mortgage would be only about 40% of what the house is worth.

So if you expected that you will get only 50% of what the house is worth, when you have to force the owner to sell it, the risk melted down over time.

Over a long period of time it seemed a risky but not to risky way to optimize your profit.

 

Now the prices/worth of houses is going down (partly because people have to sell their houses for less than what they are worth, because the can't pay their loans/mortgage back), so suddenly mortgages are much less covered by the worth of the house, the risk for the bank gets much bigger, so they have to charge more for their service. This leads to more people who have to sell their houses, letting the prices drop even more ...... And down we go!

[hrothgar]

Suppose a guy buys a house for $500,000 and there is a 10% drop in value These figures are pretty realistic these days. In a sense, he can save $50,000 by telling the bank to take this house and shove it. But he has to live somewhere. Even at the height (or depth maybe) of mortgage nonsense I don't think people with foreclosures on their records were finding it easy to get a new mortgage.

My understand is that a fairly significant number of people walked away from their mortages the last time the housing market imploded

 

I suspect that Phil might be in a good position to answer this given his background in real estate (admittedly he does commercial, not residential)

[Winstonm]

Mbodell has a good grasp of this problem and explains it well.

 

I might add that central banks' actions have little effect as the credit crunch is in the capital markets, where demand for Asset Backed Commercial Paper has fallen to zilch. Without the ability to package and resell loans, banks have to hold the notes, thus reducing the amount of mortgage money available while lending standards tighten.

 

The problem is not one of liquidity but of insolvency - home prices simply have to falll to affordable levels for any real solution long term.

 

 

Hotshot:

Banks earn money by giving out loans. The money they want for that service, depends on the risk they take.

 

This may have been true years ago but not so now - the securitization process has turned banks into originators of loans, who simply collect fees for this service. The actual loans have been packaged and sold into the capital markets as asset backed commercial paper, most in the form of CDOs - collateralized debt obligations. The risk of default has been passed on to the holders of these bonds, who now want no part in buying any more mortgage-backed bonds.

[kenberg]

Suppose a guy buys a house for $500,000 and there is a 10% drop in value These figures are pretty realistic these days. In a sense, he can save $50,000 by telling the bank to take this house and shove it. But he has to live somewhere. Even at the height (or depth maybe) of mortgage nonsense I don't think people with foreclosures on their records were finding it easy to get a new mortgage.

My understand is that a fairly significant number of people walked away from their mortages the last time the housing market imploded

 

I suspect that Phil might be in a good position to answer this given his background in real estate (admittedly he does commercial, not residential)

I not only acknowledge I pretty much insist I don't have a good grasp of this. It is another of those things that it is important to get right but hard to grasp.

 

People who own houses and rent them out, especially those who do it as a business rather than a temporary convenience, will no doubt be inclined to walk away if the house value falls below the mortgage debt. But for the guy who bought a house to live in? Where does he go? If he has a choice, that is if he is able to make his payments on the mortgage, I would expect him to make a rational choice. He has neighbors, his kids go to school, if he keeps paying he will someday own it, etc. It seems to me that the gap between the value of the house and the amount of the mortgage would have to be huge for this to overcome all the reasons that he has to stay put and ride it out.

 

I appreciate comments, especially from those whose professional experience gives them detailed knowledge, but still I want to grasp this so it makes sense to me. Or as much sense as possible. I am getting a nagging feeling that we as a country have lost touch with reality on some financial matters.

 

By the way, Al, I think the usury laws were a casualty of hyperinflation in the 70s. The current credit card situation reminds me of the old song "16 tons": "St Peter don't you call me cause I can't go, I owe my soul to the company store". They lure you in, you make some error, they jack up the rates, they own your soul. It's a different story from the mortgages but I think they share the property of unsustainability.

[PassedOut]

btw shouldnt credit card debt at 20+ % pa count as usury and arent there laws against that? :)

Usury for sure, but the laws have gradually been changed to allow it.

[ArcLight]

This will explain the Sub Prime situation

 

http://www.youtube.com/watch?v=SJ_qK4g6ntM

 

This will help explain teh US invasion of Iraq

 

http://www.youtube.com/watch?v=Ptzml1qQvZE

 

 

People can't afford to pay the new (higher) interest.

They can not sell their house without taking a large loss.

Can't stay, must go. Someone takes a loss.

 

 

>>Suppose a guy buys a house for $500,000 and there is a 10% drop in value These figures are pretty realistic these days. In a sense, he can save $50,000 by telling the bank to take this house and shove it. But he has to live somewhere. Even at the height (or depth maybe) of mortgage nonsense I don't think people with foreclosures on their records were finding it easy to get a new mortgage.

 

1. the lender can come after you, depending on the loan and jurisdiction.

 

2. Even if you are able to get away the IRS will count that as $50,000 of income and charge you taxes. Yes, thats right, you may owe taxes on a loss.

 

3. the banks originated the loans and then sold them. Most banks don't retain 100% of all loans they originate. The investors who bought these loans will get killed, depending on the seniority of the bond.

 

 

>>To throw another thought into the mix: In some ways, the collapse of the housing market is (or at least in some ways could be) a good thing. With houses getting back to realistic prices it might mean that people can afford to get in. They will no longer be able to do it with the so-called creative financing but if they have a sound financial setting then they can get a sensible mortgage on a sensible house that is going for a sensible price. Of course if everyone is out of work from the depression then this optimistic scenario falls flat.

 

While I have little sympathy for teh investors, and for most of the borrowers, some were mislead (and cheated). The problem with a mass melt down is it harm many others, and other industries. It better to have a gradual decline rather than 2 million foreclosures.

 

I am really annoyed at the idea of a government bailout in the form of guaranteed loans for thes epeople. Why should my (tax payer) money be used to bail out a speculator. Maybe suspend teh taxes on the losses, or provide some liquidity, but no way should the goverment bailout a home owner. The borrowers were hoping they could refinance before their rate adjusted. Too bad. You took a gamble and lost. If you go bankrupt for a stupid decision thats your problem.

 

 

>Many people feel that they are safe because they've used derivatives to hedge various positions, but if the people on the other side of the positions can't pay then even the hedges fall apart and chaos ensues.

 

As some large banks are just realizing with the down grading of large insurance companies. CIBC will have to take an additional 2 Bil in losses becaus ethe insurance company that guaranteed them ahs been downgraded to CCC.

[P_Marlowe]

I that's true isn't it wort it to lose your house and buy it on the auction?

Gerben mentioned the mayor reason.

 

And depending on the laws, the bank will

get the house and sell it, but this does not

mean (!), that you got rid of your complete

loan, at least in Germany you still owe the

bank the missing money, ...

unless you declare your self bancrupt, which

requires that you make your finnacial situation

public, and you are under surveilance for a

couple of years.

 

With kind regards

Marlowe

 

PS: And of course you may not get your house

back at a cheap price.

Afterall an auction is open to all.

[sceptic]

if someone cant afford the mortagae where are they going to get the money to buy the house at auction, if they cant afford the repayments, surely they cant afford to buy the house

 

It would appear to me you are thinking too much, there are easier ways and certainly more legal ways to earn money

[helene_t]

My parent lived with their parents until they had finished their education and got decent jobs.

 

I left my mother's house when I was 18 and started earning real money when I was 20, and many young people had an even longer gab.I think it's the same today, except that young people have even more expensive "needs" today than they had when I was young.

 

A colleague of mine who is from Italy found it very strange that I never received any financial support from my parents since I was 18 and that that's more or less the norm in Denmark (in fact I payed for my own food etc. since I was 16 although mummy payed the rent). She says that in Italy it's quite normal to be dependent of your parents until you are 35.

 

My point is that the breaking-up of the bonds between generations make young people more susceptible to taking loans.

 

Also, back in the 70s when inflation was 12% p.a. your dept, if you had any, was soon degraded by inflation.