The End of the Credit Crisis 49 comments
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Now sit around in a circle, kiddies, and let me tell you the story of the credit crisis. It goes like this.
Homeowner owns a $400,000 home secured by a $500,000 mortgage. Homeowner is very concerned that the value of the home could drop to $300,000 in the next few years, which is when he plans to sell the home, and he does not have the $200,000 in cash to make up the balance and pay off the full mortgage. Currently, Homeowner is thinking foreclosure is the best and only option to avoid going into further debt.
Bank has a worse problem, because Bank has a $500,000 mortgage on its balance sheet but no investor is willing to buy it for more than $100,000. The reason why is because investors know that the security on this loan is worth $400,000 and that it will probably continue to deteriorate in value. More importantly, the investors know that Homeowner has a strong incentive to let this thing go to foreclosure soon, at a time when the underlying property is rapidly losing value. Finally, investors see the value of other mortgages falling rapidly, and don’t want to catch a falling knife.
Now we’re getting to the crux of Bank’s biggest problem, which is that under some clever accounting rules, Bank needs to mark this mortgage to market. Bank knows that the mortgage is not worth $500,000, but right now if they went to foreclosure, Bank would get $400,000 because that is what the collateral would sell for. However, under the mark to market rules, the value of this mortgage is not $400,000 – it’s $100,000 because that is what an investor would pay for it.
You see where this is going. Under banking regulations, Bank needs $1 in the vault for every $10 that Bank lends out. If Bank’s $500,000 mortgage is worth $100,000, that translates to $4,000,000 that Bank can no longer lend out. Bank must curtail its lending dramatically, which means less profits for Bank, and less liquidity in the system. No good. And even worse, Bank just reported a $400,000 write-down to its overjoyed shareholders, and hedge funds are now taking Bank’s market capitalization down by 90%. The public watches the 90% decline in the price of Bank stock, and forms a view that the banking system may be failing. Hedge funds act on this fear by short selling Bank stock with verve and confident greed, sending the share price down further still, and reinforcing a sense of panic among the public. Other investors are jumping on the bandwagon, too, and short interest on Bank’s stock is now close to 50%! (Pssst – remember that short interest thing for later, okay?).
Bank management has an idea. They believe that foreclosure is the best solution to this problem because by forcing Homeowner into foreclosure, the mark to market accounting rules permit Bank to report that $500,000 mortgage not as an asset worth $100,000, but rather, as $400,000 in cash. Moreover, Bank is concerned that if the secondary market for mortgages deteriorates, further write downs will become necessary, feeding the downward spiral in its share price and profitability.
This story plays out across the economy, and results in foreclosure rates that surpass those during the Great Depression, and the sharpest and worst decline in bank capital in history. The world, it feels, may be ending.
Time to short Citibank (C)? Bank of America (BAC)? What about JP Morgan (JPM)? Well hold on, kiddies, let me finish the story.
Some clever folks who work for President Obama have an idea. They say, let’s order the banks to renegotiate all those underwater mortgages! It’ll look like we’re punishing Bank, and helping the little guy. But what we’re really doing is solving the credit crisis, and tossing Bank a nice juicy bone in the process.
See, right now, Bank has a $500,000 mortgage that is about 50% likely to go into default, and nobody will buy that mortgage because it’s got lousy creditworthiness. Bank doesn’t want to mess with renegotiating any mortgages in a bankruptcy court, so Bank goes straight to Homeowner and says “Homeowner, now you only owe us $300,000, which you can afford to pay us back.” Homeowner is delighted, and now has no incentive to go into default. This fact is not lost on investors who like to buy mortgages that are a good credit risk. Anything will beat those Treasuries that only pay 2.5% a year.
Suddenly, this $300,000 mortgage is a very good credit risk, and investors are far more willing to buy it – in fact, investors will pay a whole lot more for a high quality $300,000 mortgage than a very low quality $500,000 mortgage. In fact, investors are ready to pay $300,000 for that high quality $300,000 mortgage. So what does Bank get to do?
You guessed it. Bank takes a WRITE UP. For tax purposes, Bank claims a tax deduction for the $200,000 it just wrote off the mortgage (which boosts up Bank’s balance sheet right on the spot), but for accounting purposes, Bank writes the mortgage up from $100,000 to $300,000. Bank announces these write ups as a surprise profit next quarter, completely stunning the stock market in the process – most investors had just assumed Bank was going to fail or be nationalized. But nobody expected WRITE UPS!
And this adjustment to Bank’s balance sheet frees up ten times as much capital that Bank can now lend out. The news of increased lending is equally surprising, and the stock market greets the news with enthusiasm. Yes, the clever people in President Obama’s administration are starting to look rather clever indeed.
Hey, turning to reality for a minute, do you want to know what? Some bank executives this author talks to actually GET IT, see? This is really the plan.
But back to my story. Remember what happened with Volkswagen stock last year?
The U.S. Treasury has been purchasing Bank’s common equity. There just aren’t that many shares of Bank stock available to buy. Turning back to reality for a moment here, anyone notice what Treasury said about buying Citigroup stock? WONDER WHAT THAT’S ABOUT, KIDDIES? Let me finish the story and you soon will.
When Bank reports that surprise write up of the mortgage on its balance sheet, some short sellers decide to cover. Quickly. The problem the short sellers have is, they are all trying to cover their short positions all at once! And the even bigger problem is that because Treasury has been buying up Bank stock quietly, THERE IS NOT ENOUGH BANK STOCK ON THE MARKET TO COVER THE SHORT INTEREST. This is a case where demand for Bank stock is larger than the supply, and the higher the price of Bank stock goes, the higher the demand for the stock goes. Only Treasury won’t sell Bank stock. And momentum traders have just figured out what’s going on and have decided to ride this trend to the moon. Short sellers, one by one, go bankrupt.
And then the big bad wolf eats them.
The end.
Disclosure: Author owns shares of BAC and JPM.
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This article has 49 comments:
If you believe the scenario, and you don't own bank stocks, then you don't believe the scenario.
On Feb 27 09:41 AM joe shmoe wrote:
> So what happens to those of us who actually can afford our loans?
> We get no write down on the principal of our loans? While rising
> values of BAC C JPM would be a nice offshoot of all this, how does
> it affect those of us in the "we own no bank shares" and we won't
> see any renegotiated mortgages offered to us? Sounds like we're
> rewarding the STUPID buyer who couldn't really afford his 500k loan,
> and the STUPID banks who loaned those people too much money. Damn
> I should have bought a mansion 6 months ago, and let the gubment
> and the banks bail me out. Shucks, what was I thinking taking only
> a mortgage I could afford?
It makes a lot of sense to me. Those who think they're smarter and have a better sense of economics than Geithner, Volker, Summers, Buffet and the other Obama advisors are due for a little crow-eating, in my opinion.
Thanks for an excellent article that put the whole thing in perspective for me.
Therefore, there's no "writeup" ahead, only writedowns for the bank in your story. And if the "smart guys" get their cramdown wishes, you'll see a reduction in lending as bank equity takes a hit.
That's one reason why the gov't is going to be putting so much more equity into the banking system - there's a lot of impairment to be realized in the near future
Thanks for your comment.
On Feb 27 09:38 AM J. D. Swampfox wrote:
> The shares in the banks that the government owns are newly issued
> shares, not purchased from the existing supply in the market. Further,
> IF the banks take "write-ups" from the scenario you lay out, the
> value of them to existing private shareholders will have been diluted
> by the percentage controlled by the government. In the case of Citi,
> as of today, this is currently about 40%, but it looks increasingly
> like it will soon be 80% a la RBC in the UK. Skyrocket from write-ups?
> Sounds tenuous, at best...
On Feb 27 11:00 AM User 75493 wrote:
> You miss one thing - individual (nonsecuritized) loans aren't written
> down until they distressed - usually 90 days deliquent. This loan
> is still on the books at 500k until the homeowner misses payments
> or the bank is sure the borrower isn't going to pay it back.
> Therefore, there's no "writeup" ahead, only writedowns for the bank
> in your story. And if the "smart guys" get their cramdown wishes,
> you'll see a reduction in lending as bank equity takes a hit. <br/>That's
> one reason why the gov't is going to be putting so much more equity
> into the banking system - there's a lot of impairment to be realized
> in the near future
Look, our tax code wasn't designed for today's realities. Period. Get on board and write to your Congress person about cleaning up the system. I am.
On Feb 27 10:17 AM User 365522 wrote:
> The author fails to account for the tax effect on the borrower. The
> $200,000 write down by the bank is considered taxable income to the
> borrower, payable immediately. That will put the borrower into the
> highest tax bracket (which is going up even further). The tax owed
> will be about $80,000. Where does the borrower get that money? The
> bank survives, it stock price soars, while the borrower gets hit
> with a tax bill he can't hope to pay (or discharge through bankruptcy).
> Great plan!
I say make them pay the tax. We get to pay the write down with tax dollars so he should help replentish them.
buyers will only pay 100k for bad $500k loan which is worth $300K...
but willing to pay $300K for a good $300K loan...
Ignoring tax benefits, why would the buyer not pay $100k for bad $500K loan and writedown the $200K. Hence get a good $300k loan for $100K and make 200% profit? Why not write down the loan to $200K - super save - and make 100% profit?
Isn't this the crux of stumbling block, banks are not willing to sell their loans for the fraction of what they paid for it nor reduce the principle? The $500K loan has a good part (repayable without foreclosure) so why is it worth only $100K unless that is what the expected repayment is.
On Feb 27 02:26 PM who wrote:
> I'm no tax expert but a bit lost....
>
> buyers will only pay 100k for bad $500k loan which is worth $300K...
>
>
> but willing to pay $300K for a good $300K loan...
>
> Ignoring tax benefits, why would the buyer not pay $100k for bad
> $500K loan and writedown the $200K. Hence get a good $300k loan
> for $100K and make 200% profit? Why not write down the loan to
> $200K - super save - and make 100% profit?
>
> Isn't this the crux of stumbling block, banks are not willing to
> sell their loans for the fraction of what they paid for it nor reduce
> the principle? The $500K loan has a good part (repayable without
> foreclosure) so why is it worth only $100K unless that is what the
> expected repayment is.
>
>
>
On Feb 27 10:17 AM User 365522 wrote:
> The author fails to account for the tax effect on the borrower. The
> $200,000 write down by the bank is considered taxable income to the
> borrower, payable immediately. That will put the borrower into the
> highest tax bracket (which is going up even further). The tax owed
> will be about $80,000. Where does the borrower get that money? The
> bank survives, it stock price soars, while the borrower gets hit
> with a tax bill he can't hope to pay (or discharge through bankruptcy).
> Great plan!
On Feb 27 02:26 PM who wrote:
> I'm no tax expert but a bit lost....
>
> buyers will only pay 100k for bad $500k loan which is worth $300K...
>
>
> but willing to pay $300K for a good $300K loan...
>
> Ignoring tax benefits, why would the buyer not pay $100k for bad
> $500K loan and writedown the $200K. Hence get a good $300k loan for
> $100K and make 200% profit? Why not write down the loan to $200K
> - super save - and make 100% profit?
>
> Isn't this the crux of stumbling block, banks are not willing to
> sell their loans for the fraction of what they paid for it nor reduce
> the principle? The $500K loan has a good part (repayable without
> foreclosure) so why is it worth only $100K unless that is what the
> expected repayment is.
>
>
>
On Feb 27 09:41 AM joe shmoe wrote:
> So what happens to those of us who actually can afford our loans?
> We get no write down on the principal of our loans? While rising
> values of BAC C JPM would be a nice offshoot of all this, how does
> it affect those of us in the "we own no bank shares" and we won't
> see any renegotiated mortgages offered to us? Sounds like we're
> rewarding the STUPID buyer who couldn't really afford his 500k loan,
> and the STUPID banks who loaned those people too much money. Damn
> I should have bought a mansion 6 months ago, and let the gubment
> and the banks bail me out. Shucks, what was I thinking taking only
> a mortgage I could afford?
On Feb 27 01:18 PM doubleguns wrote:
> With ref to the 200,000 in tax.
>
> I say make them pay the tax. We get to pay the write down with tax
> dollars so he should help replentish them.
Eliminate the mark to market rule so that banks don't have to take these write-downs and suffer huge losses to their asset base..
Curtail excessive short selling by reinstating the up-tick rule so that stock prices are not tanked by speculating traders.
Eliminate fractional reserve banking so this kind of thing doesn't happen again in the future.
I think it is totally wrong to pay taxes on a home you live in .
We are originally from Germany, we know all about high taxes, but this is the craziest thing in the history of taxation.
On Feb 27 10:17 AM User 365522 wrote:
> The author fails to account for the tax effect on the borrower. The
> $200,000 write down by the bank is considered taxable income to the
> borrower, payable immediately. That will put the borrower into the
> highest tax bracket (which is going up even further). The tax owed
> will be about $80,000. Where does the borrower get that money? The
> bank survives, it stock price soars, while the borrower gets hit
> with a tax bill he can't hope to pay (or discharge through bankruptcy).
> Great plan!
When that house, that is worth only $300k, was sold for $500k, its seller pocketed a $200k "bubble profit". Seems to me that fairness dictates that the sellers who unreasonably profited by selling inflated real estate should be the first to contribute the unwinding of this bubble. Why not a "windfall profit tax" on sellers of real estate during the great bubble, just like we had on oil companies after the oil price spike in 1979. I'd suggest that this is more fair than charging the loss to those who have not participated, nor profited from the bubble.
The treasury can create a table of "artificial inflation" percentages, defined by geographic area and by month/year of the bubble, and all real estate transactions in this area/month/year would be subject to an appropriate windfall profit tax, payable in installments over five years.
If you bought a property in Las Vegas in 2005 and you hold it still today, then you have suffered a loss. The fact that you did not sell doesn't make any difference.
A loss by any other name is still a loss.
On Feb 28 11:15 AM henarl wrote:
> A straightforward description of the housing and banking crisis that
> anyone with at least an average IQ should be able to understand.
> Instead of the Obama solution tho, I would suggest the following:
>
> Eliminate the mark to market rule so that banks don't have to take
> these write-downs and suffer huge losses to their asset base..<br/>Curta...
> excessive short selling by reinstating the up-tick rule so that stock
> prices are not tanked by speculating traders.
> Eliminate fractional reserve banking so this kind of thing doesn't
> happen again in the future.
A mortgage (or any amount) on a house worth $400,000 is worth more than a mortgage on a house worth $300,000. The example is nonsense.
Yes, Obama idea is brilliant: convert US real estate housing market into free-rent "public housing".
Then, why stop there? The next will be commercial real-estate, etc.,
Just one question: who will "eat" all these losses?
PS
Free lunch has to stop somewhere. Otherwise, farmers will stop growing food. Of coarse, Obama can nationalize agriculture the way it was done in Soviet Union and China (who counts 10% of the entire population starved to death and additional 60% were enslaved.)
It is hardly as though we have any choice other than to bail out the banks. And if the American people have to rescue the banks to save themselves, then the American people should get a good deal.
Upside, not just downside.
Obstinate clinging to a clearly discredited ideology is why your side on the bench ...
On Feb 28 05:06 PM nova wrote:
> Great, who needs Karl Marx or Adam Smith? We have Obama geniuses.
>
>
> Yes, Obama idea is brilliant: convert US real estate housing market
> into free-rent "public housing".
>
> Then, why stop there? The next will be commercial real-estate, etc.,
>
>
> Just one question: who will "eat" all these losses?
>
> PS
> Free lunch has to stop somewhere. Otherwise, farmers will stop growing
> food. Of coarse, Obama can nationalize agriculture the way it was
> done in Soviet Union and China (who counts 10% of the entire population
> starved to death and additional 60% were enslaved.)
Can this be dealt with outside the bankruptcy courts?
If the answer is no the shorts may be right.
Excellent article though.
Not until real estate values stop dropping will this crisis abate. No Obama economic team accounting gimmick can rescue this. As real estate values crater, business declines, unemployments rises, foreclosures increase and real estate craters more: a nasty self feeding cycle. It is something, painful as it will be and as much suffering as it will cause, we have to go through. Markets work, government's artificial solutions don't.
There are a lot of sins that a society can commit but it can never fool with its real estate / mortgage markets. They are just toooooo big. Unfortunately, that is what we did: supprime, mortgage equity withdrawals, liar loans, teaser loans, fannie/freddie, etc. The losses are mind blowing. They will need to be amortized by our nation over many years.
This is not a Black Swan. This was a guaranteed time bomb put into motion by the government's stupid but well intentioned desire to have everyone own a home, structured finance thievery and our old capitalist friend, unabated greed.
Too bad Aeschylus is not still around. He would of written a wonderful tragedy with this material.
On Feb 27 09:41 AM joe shmoe wrote:
> So what happens to those of us who actually can afford our loans?
> We get no write down on the principal of our loans? While rising
> values of BAC C JPM would be a nice offshoot of all this, how does
> it affect those of us in the "we own no bank shares" and we won't
> see any renegotiated mortgages offered to us? Sounds like we're
> rewarding the STUPID buyer who couldn't really afford his 500k loan,
> and the STUPID banks who loaned those people too much money. Damn
> I should have bought a mansion 6 months ago, and let the gubment
> and the banks bail me out. Shucks, what was I thinking taking only
> a mortgage I could afford?
IR-2008-17, Feb. 12, 2008
WASHINGTON — Homeowners whose mortgage debt was partly or entirely forgiven during 2007 may be able to claim special tax relief by filling out newly-revised Form 982 and attaching it to their 2007 federal income tax return, according to the Internal Revenue Service.
Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec. 20, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was $2 million or less. The limit is $1 million for a married person filing a separate return. Details are on Form 982 and its instructions, available now on this Web site.
“The new law contains important provisions for struggling homeowners,” said Acting IRS Commissioner Linda Stiff. “We urge people with mortgage problems to take full advantage of the valuable tax relief available.”
On Feb 28 12:41 PM prudentinvestor wrote:
> I'll propose another solution, which, I fear some will find shocking:
>
>
> When that house, that is worth only $300k, was sold for $500k, its
> seller pocketed a $200k "bubble profit". Seems to me that fairness
> dictates that the sellers who unreasonably profited by selling inflated
> real estate should be the first to contribute the unwinding of this
> bubble. Why not a "windfall profit tax" on sellers of real estate
> during the great bubble, just like we had on oil companies after
> the oil price spike in 1979. I'd suggest that this is more fair than
> charging the loss to those who have not participated, nor profited
> from the bubble.
>
> The treasury can create a table of "artificial inflation" percentages,
> defined by geographic area and by month/year of the bubble, and all
> real estate transactions in this area/month/year would be subject
> to an appropriate windfall profit tax, payable in installments over
> five years.
Why couldn't Bank write down the loan on their books to its present value of 400K rather than 100K?
Isn't there some leverage on these defaults that is causing the trouble? The infamous "CDOs and CDSs?" that even Greensapan can't understand and AIG sold without collateral? Isn't it something like: if the loans go bad, the CDOs get valuable for the holder? This I think is the missing "atomic bomb" and why the gov't is trying everything it can to wipe out the home value losses. Despite the fact that the home values were inflated falsely - and now we are trying to keep them falsely inflated.
On Mar 01 08:03 AM MJJP wrote:
> Something is still missing from the puzzle.Something is wrong and
> we are not being told. People never bailed out on mortgages just
> because the value of the home was deteriorating. Home values go up
> and down all the time for any number of reasons. So far the unemployement
> rate is only around 8% or so and that should'nt trigger a massive
> wave of defaults. If the homeowner is still working they should still
> be paying. Secondly if the banks loaned out more money than was prudent
> using the ratio of deposits on hand why isn't the savings rate interest
> rising? Come on they think people are going to put money into a CD
> are 2%!
But then, the wrong problem is solved! Whatever happened to the LBO's, CDO's and swaps. In other words the mountain of toxic paper that was sold to every one on the planet which is now essentially worthless. That is what this crisis is all about, not mortgages directly. The banks have effectively disintigrated their balance sheets. Then let's look at the nominal value of all the derivative products, said to be in the range of 600 trillion, even God doesn't have that kind of money. So what is Bank's problem: excessive leverage in some cases 100:1. It is time to pay the piper. So far 50 T has come off in this meltdown and that is just a down payment. This mess is not solveable by government, they will just make it worse.
On Feb 27 10:57 AM Tetrapod wrote:
> Brilliant!
> It makes a lot of sense to me. Those who think they're smarter and
> have a better sense of economics than Geithner, Volker, Summers,
> Buffet and the other Obama advisors are due for a little crow-eating,
> in my opinion.
> Thanks for an excellent article that put the whole thing in perspective
> for me.
Basically, we've been living on false money creation for so long we didn't even know it. That built up a huge, unaffordable over-leveraging. During that time, we all made money on inflation, and now we are going to have deflation remove that money. And it will be real removal of life style, not just a equal division by 1.7 or something that leaves everything relatively the same. That's why even prudent people will owe money to pay for the deadbeats, because we ALL got richer on leverage than we should have (even if we never took a loan).
On Mar 01 04:31 AM Tranquilmeditation wrote:
> I appreciate the author's optimism in a time of despair but this
> is fantasy. For example, 50% of the mortgages in California are
> now under water (negative equity) and real estate prices are still
> dropping. Someone will have to realize these massive losses. <br/>
>
> Not until real estate values stop dropping will this crisis abate.
> No Obama economic team accounting gimmick can rescue this. As real
> estate values crater, business declines, unemployments rises, foreclosures
> increase and real estate craters more: a nasty self feeding cycle.
> It is something, painful as it will be and as much suffering as it
> will cause, we have to go through. Markets work, government's artificial
> solutions don't.
>
> There are a lot of sins that a society can commit but it can never
> fool with its real estate / mortgage markets. They are just toooooo
> big. Unfortunately, that is what we did: supprime, mortgage equity
> withdrawals, liar loans, teaser loans, fannie/freddie, etc. The losses
> are mind blowing. They will need to be amortized by our nation over
> many years.
>
> This is not a Black Swan. This was a guaranteed time bomb put into
> motion by the government's stupid but well intentioned desire to
> have everyone own a home, structured finance thievery and our old
> capitalist friend, unabated greed.
>
> Too bad Aeschylus is not still around. He would of written a wonderful
> tragedy with this material.
"Some tax lawyer you are--homeowners who have a portion (or of the mortgage debt written down will not have to pay tax (up to $2M)"
WOW! Obama and the Congress are great. Who needs taxes? They will print more monopoly (US$) money.
"Poor souls" who took $2M+ mortgages. My heart is going for them. So far, I have not seen a single message clearly stating that the overwhelming majority of people losing their houses are ones who speculated and gambled.
Who said that everybody buying a lottery ticket is entitled to a $1M-win? Who said that investing in stock markets guaranty a fortune?
Sorry folks, it is the time to pay the piper and become responsible for your own actions!
The banks have refused to allow investors to see what they have written down so HOW DO YOU KNOW?
"The shares in the banks that the government owns are newly issued shares, not purchased from the existing supply in the market. Further, IF the banks take "write-ups" from the scenario you lay out, the value of them to existing private shareholders will have been diluted by the percentage controlled by the government. In the case of Citi, as of today, this is currently about 40%, but it looks increasingly like it will soon be 80% a la RBC in the UK. Skyrocket from write-ups? Sounds tenuous, at best."
To your two points:
1) The author is talking about Treasury actuallu buying up stock on the open market as part of the plan is as a 'covert PPT operation'. You are confusing that with TARP and TARP 2. Two different things.
2) It was at Citi's request that Treasury converted a portion of the TARP preferreds into common. In the early mid 90s during that last bank recession, Citi sold a huge chunk and diluted itself to the rafters. It then when on to gain 5000% in the following 4 years. Citi knows and understands dilution. On the other hand, you just think its a scary word.
"You miss one thing - individual (nonsecuritized) loans aren't written down until they distressed - usually 90 days deliquent. This loan is still on the books at 500k until the homeowner misses payments or the bank is sure the borrower isn't going to pay it back..."
Its the securitized loans that are the problem, sitting in the retained mbs portfolios of all the banks. These are, as the author notes, absurdly marked down below the true recovery vlaues.
"So far the unemployement rate is only around 8% or so . . ."
Government unemployment figures are devised to underestimate unemployment by about 50% (?). More important to housing, ANY employment makes a person employed. If, for example, a person working three jobs bought a house and can no longer afford the payments because s/he now has only one of those three jobs, that person is still considered to be employed. Similarly, a two income family newly reduced to one income will likely not be able to continue the payments on a house bought on the assumption that both would continue to have incomes.
SO: Official unemployment and housing are connected in loose and complicated (i.e., difficult to understand) ways.
You are right there is something missing and I will keep reposting it, until everybody knows it.
These two statements say it all, if you can do simple math (from Mortgage Liquidity Du Jour by Credit Suisse, March 2007)
"low/no documentation loans increased from just 18% of purchase originations in 2001 to 49% in 2006"
"sampling 100 stated income loans found that 60% of borrowers had "exaggerated" their income by MORE than 50%"
That means 30% of ALL mortgages in 2006, the buyer only had 66% of the income they claimed. Some of the other mortgages were also likely bad from minute one. If the buyer lied by 49% or 30% on their application?
Congress voted against oversight of Fannie and Freddie in 2003 and so most of congress is not really motivated to come out with the entire open truth are they!!
On Mar 01 09:53 AM delbmarcs wrote:
> I think you are right. There is something missing.
>
> Isn't there some leverage on these defaults that is causing the trouble?
> The infamous "CDOs and CDSs?" that even Greensapan can't understand
> and AIG sold without collateral? Isn't it something like: if the
> loans go bad, the CDOs get valuable for the holder? This I think
> is the missing "atomic bomb" and why the gov't is trying everything
> it can to wipe out the home value losses. Despite the fact that the
> home values were inflated falsely - and now we are trying to keep
> them falsely inflated.
On Feb 28 12:41 PM prudentinvestor wrote:
> I'll propose another solution, which, I fear some will find shocking:
>
>
> When that house, that is worth only $300k, was sold for $500k, its
> seller pocketed a $200k "bubble profit". Seems to me that fairness
> dictates that the sellers who unreasonably profited by selling inflated
> real estate should be the first to contribute the unwinding of this
> bubble. Why not a "windfall profit tax" on sellers of real estate
> during the great bubble, just like we had on oil companies after
> the oil price spike in 1979. I'd suggest that this is more fair than
> charging the loss to those who have not participated, nor profited
> from the bubble.
>
> The treasury can create a table of "artificial inflation" percentages,
> defined by geographic area and by month/year of the bubble, and all
> real estate transactions in this area/month/year would be subject
> to an appropriate windfall profit tax, payable in installments over
> five years.
I was especially skeptical of a large and permanent jump from write ups catching short sellers off guard and requiring them to cover their positions.
A quick check over at shortsqueeze .com confirms my suspicion and shows surprisingly low numbers of shorts on the major banks! A good squeeze requires investors to be short a large percentage of outstanding stock, yet BOA is only at 1 or 2% (Citi is a little worse off because of expected nationalization with ~9%). When I checked the site, they were using Superior Industries International (SUP) as a good short squeeze potential with a mind blowing 26.78 % amount of the stock being short!
Furthermore, the turnover on BOA shorts is something like .2 days which means traders are turning over their positions like wildfire specifically to keep from being caught off guard.
GM would have a much greater potential to find itself in this situation because it has 18% of its stock shorted on an 11 day horizon and could easily get a bump from a favorable government program which would, as the author implies, would cause a short squeeze requiring a sudden flurry of buying to cover positions.
As far as I can tell, there is almost zero chance that shorting traders will drive a recovery in banking stock prices, though write ups would certainly improve the incredibly negative sentiment on bank stocks and could be the beginning of a longer term recovery.
On Feb 27 09:38 AM J. D. Swampfox wrote:
> The shares in the banks that the government owns are newly issued
> shares, not purchased from the existing supply in the market. Further,
> IF the banks take "write-ups" from the scenario you lay out, the
> value of them to existing private shareholders will have been diluted
> by the percentage controlled by the government. In the case of Citi,
> as of today, this is currently about 40%, but it looks increasingly
> like it will soon be 80% a la RBC in the UK. Skyrocket from write-ups?
> Sounds tenuous, at best...
On Feb 28 02:31 AM sr9web wrote:
> Write downs only are taxable to borrowers on forgiven loans.
@WillL
On Mar 02 07:09 AM WillL wrote:
> While I enjoyed the article and was grateful for a unique perspective,
> I agree with the tenuous sentiment on a "skyrocket"
> As far as I can tell, there is almost zero chance that shorting traders
> will drive a recovery in banking stock prices, though write ups would
> certainly improve the incredibly negative sentiment on bank stocks
> and could be the beginning of a longer term recovery.
----------------------...
Just go back and look at the price action of oil in 2008-- we've seen enormous leverage and excesses in speculation come crashing down not six months ago, with the shorts getting bombed in the process.
Some portion of the financials' collapse has been genuine longs selling, but its only a portion. There's been mountains of speculative selling.
The commodities longs of early 2008 were, in many cases, the financials shorts of early 2009. Notice the similarity in the _pace_ of the movement in stocks. GE's stock graph over the last four months is, inverted, Gold's chart from April to July 2008.
So I'm going to say that the author has something here, and he's picked up something clever and logical. If you were a market-savvy economic team (which the Summers-Rubin crowd is), and you could put in place policies which have no cash cost, but which refloat the balance sheet, and the lending -- all using market appetites, you'd do that, right?
And the next sweet piece of the plan is that as this happens, you start nailing the shorts . . . who are not patient holders of anything. They stampede into a position to drive it down, and they stampede out. Take a look at when oil broke-- the speculative shorts came undone just as fast as they were put on.
No guarantees here, but kudos to author Trias for pointing out something quite ingenious.