April 15, 2009 4:49 PM | Posted by dysphoria: | Reply

The government apparently wants to protect its investment. True, it's kinda shady, but they make the rules.

I wonder how this will all look in 5 years. Assuming mortgage defaults are the cause of the problem, will the default rate be as bad as people fear? I can't find the numbers, but I recall worst case projections of ~10%. If the other 90% are paying 5% interest, total pure principal is still covered 94.5% yearly. Of the remaining 5.5%, asset value isn't 0, but must be recoverable to at least 55% of total loan liability to cover the gap.

This is an admittedly naive interpretation, as it doesn't factor in the rate banks paid for the money originally. Still, a strong majority of the initial credit is safe. Money won't be made, but it shouldn't be lost too wildly. At present, it seems like these assets are valued too pessimistically. People talk as though it's all "worthless paper", which isn't true. It's backed, at the least, by physical property, and augmented by additional interest remittance.

The precipitant of all this - falling home values - is also not a static situation. At one point, everyone was satisfied with prices, and continued to escalate them. Everyone needs a home, and that's not going to change. Prices are already closing in on historical own/rent ratios (~125%).

Banks are also benefiting from an unusually large influx of cash as consumers pay down other forms of credit, helping them remain sufficiently capitalized.

I think that once the panic is over, we'll all look around and see that the world is still here, and we overreacted. Smart people will make a lot of money in the coming years.

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April 16, 2009 2:45 PM | Posted, in reply to dysphoria's comment, by Roger: | Reply

Not too far off, but 2 points you are neglecting
leverging and margin calls.

1. God only knows how over leveraged the market was and is now. Bank A borrowed money to give out loans, and leveraged themselves out to the max of 8:1(debt to asset). Bank B leveraged 8:1 to buy up Bank A weak loans and bundle them. Bank C does the same with bank B. Bank C thinks they are 8:1, but in reality they leveraged 500:1 relative to the actual hard assets(the house themselves). On top of this, some banks were allowed to ignore the 8:1 leveraging restriction, and went as much as 50:1, these banks were the first to fold.

2. If you go enough into the red to get a margin call, you never gets the chance to break even. A margin calls prevents you from attempting to ride it out and trying to break even.

So put it together, A bank is leveraged 100:1, and the housing market swings down by 10%. The bank sees a 1000% swing in their asset value. This is enough to cause their debt from the derivatives market to actually sink an entire, relatively stable and diverse company(think AIG). Their overall asset to debt ratio plummets triggering a margin call. The margin call forces the bank to declare bankruptcy, and the FDIC has to step in and bail them out because the bank is insured.

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April 18, 2009 7:01 AM | Posted by new_job: | Reply

good article!

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