Why Banking Is Insolvent

Following up on the quick mention now that I have a story to cite from Amherst:

Cure rates for these distressed loans remain low. Amherst noted a near 0% cure rate of all loans in foreclosure, 0.8% for 90 plus days delinquent, 4.4% for 60 days delinquent and 26.5% for 30-day delinquencies. All told, Amherst expects 12.42% of units (from the 13.54% of properties delinquent and in foreclosure) to eventually liquidate.

Let's put some numbers on this.

There are roughly 125 million single-family homes in the US.

Of those, roughly 30% have no mortgage on them at all. This leaves 87.5 million single-family homes with mortgages.

Let us assume the average outstanding balance is $200,000 across the entire set and will take a 40% loss severity. This is less than S&P has estimated for subprime loans and only assumes a roughly 20% market deficiency in the home price (the rest is from legal, rehabilitation and marketing expenses.)

These numbers are, with a high degree of confidence (90%+) low - that is, losses will exceed these estimates, perhaps dramatically so. It is, for example, quite reasonable to believe that due to the concentration of defaults in higher-priced areas (e.g. California and Florida) that the average outstanding balance could be close to double that $200,000 value and the loss due to negative equity higher.

From this we can develop a "cocktail napkin" view of the losses to be taken in home mortgages for single-family homes (remember, this does not include condos, apartment buildings and similar "commercial" paper.)

$200,000 X 40% = $80,000 loss per foreclosure.

87.5 million homes with mortgages X 12.42% = 10,867,500 foreclosures.

10,867,500
x 80,000
=============
$869,400,000,000

or $869 billion in losses remaining in single-family mortgages alone.

What if the average outstanding is higher and negative equity greater than 20% (which is likely)? Losses will almost certainly be well north of a trillion dollars.

The entire banking system and likely The Fed, given the quantity of Fannie (FNM) and Freddie (FRE) paper it has been and is "eating", is insolvent. These facts are why the government is lying - they're well-aware of the near-zero cure rates and know that these facts mean that the banking industry has nowhere near sufficient capital to withstand these losses without folding like a paper cup getting stomped on by an elephant.

(Remember that these numbers do not include any commercial real estate losses, and we have found that banks are frequently over-stating their claimed values for these loans by 50% or more - as was seen with Colonial.)

It gets better. The FDIC has a negative balance both in its fund balance and the reserve ratio projected for the end of the quarter, which is, big surprise, tomorrow. Oh, and there is this pesky problem that the FDIC has - contrary to its mandate - been issuing bond guarantees for banks, so if and when that banking insolvency is recognized the FDIC will implode into a gravity well also, since it is on the hook for the entire deficiency of those bonds that were issued with its "guarantee" should they default.

Care to argue with the math folks?

Comments

[syracuse95:]

Actually, I would care to argue with the math.

First of all, let's use real (not assumed) numbers. According to the Federal Reserve's Q2 Report, released this month, the total value of all outstanding mortgages at the end of Q2 was $15 trillion. Assuming that Amherst's 12.42% default rate is correct, then there are potentially $1.8 trillion in mortgage defaults coming. Also assuming your 40% loss per default is correct, the total losses would be 40% of $1.8 trillion, or $720 billion, about 17% lower than your number.

Here's the problem...

That $15 trillion in outstanding mortgages includes multifamily, commercial, and farm mortgages. So even including the commercial loans you said WEREN'T included, I still can't get to your number.

The Fed doesn't publish single-family only statistics, but they do publish 1-4 family dwelling statistics. There is currently $10.9 trillion in outstanding mortgages on 1-4 family dwellings. Using the 12.42% default rate and 40% loss per default on $10.9 trillion, there would be $540 billion in losses, not $869 billion. You overshot by about 60%.

So, the math doesn't work. I'll let others argue the 12.4% default and 40% loss assumptions.

Sep 29 07:59 PM

[Karl Denninger:]

You folks who are smoking things need to put down the pipe.

The number on "no mortgage" homes is 30%, not 50%. The single family housing units I got from multiple published sources (and used an average.)

All of the other assumptions are stacked to FAVOR a low-ball figure. Homes in California are much more expensive than in Arkansas, for example, and that's where the foreclosure percentages are higher.

The point of this article is that the claim that "only 5%" of loans will ultimately foreclose (based on 120+ delinq) is a FARCE. That's not my claim - it's the claim made on Bloomberg this morning by a group that has done the math and which is now backed up with a written opinion by them in the published media.

Karl L, I have no duty to respond to you. I will deal with your unwarranted harassment in the filing of "disputes" with SA - you can count on it.

Sep 29 08:01 PM

[PPY:]

Hi Karl

Please write a post and help explain this:

Next up, the stupid and unreasonable loss sharing agreement at OneWest, where FDIC gifted these new IndyMac owners with profits at the expense of taxpayers and Bair's own loan modification effort?
trulia.com/blog/bob_he...

Thanks

Sep 29 08:31 PM

[PPY:]

Please help explain this:

Next up, the stupid and unreasonable loss sharing agreement at OneWest, where FDIC gifted these new IndyMac owners with profits at the expense of taxpayers and Bair's own loan modification effort?
trulia.com/blog/bob_he...

Thanks
On Sep 29 08:01 PM Karl Denninger wrote:

> You folks who are smoking things need to put down the pipe.
>
> The number on "no mortgage" homes is 30%, not 50%. The single family
> housing units I got from multiple published sources (and used an
> average.)
>
> All of the other assumptions are stacked to FAVOR a low-ball figure.
> Homes in California are much more expensive than in Arkansas, for
> example, and that's where the foreclosure percentages are higher.
>
>
> The point of this article is that the claim that "only 5%" of loans
> will ultimately foreclose (based on 120+ delinq) is a FARCE. That's
> not my claim - it's the claim made on Bloomberg this morning by a
> group that has done the math and which is now backed up with a written
> opinion by them in the published media.
>
> Karl L, I have no duty to respond to you. I will deal with your
> unwarranted harassment in the filing of "disputes" with SA - you
> can count on it.

Sep 29 08:33 PM

[megatrend:]

Nice article and thought provoking comments. Maybe some of you would want to taks a look at the Kansas supreme court's ruling regarding the MERS system and the precedent it set. This could open another can of worms in the housing market and caal to question the legality of all these foreclosure auctions. Interesting times ahead.
megatrend2010.webs.com

Sep 29 09:15 PM

[437339:]

Re

A lot of these homes are in foreclosure as lots of folks ran up the ATM , home equity line to finance their lifestyles as their wages did not keep up with inflation . This area is going to get worse , as many folks looking for work are only going to get a fraction of what they formerly made .Add to this the defaults going to arise from the " cash for clunkers ' program + defualts on mortgages made now because of the 1st time buyers 8000 tax rebate . NONE of this is going to end well ! + DONT forget credit cards !

Sep 29 09:45 PM

[Mark Anthony:]

Karl:

Your math is completely frauded as the numbers are exxagerated. Not all foeclosures are under-water. It's likely that only the foreclosures of houses bought during 2005-2008 housing price peak are now under water. Actually only NEW BUYERS who bought during 2005-2008 who now foreclose, are under-water. If one sold a house bought in 1999 and bought another one of similar price, it is unlikely to be underwater now.

The foreclosure.com web sites lists roughly half millon foreclosures and half million pre-foreclosures. That's a far cry from your 10.867M foreclosures estimate. Your average $80K loss per foreclosure is also highly exagerated.

The most ridiculous claim you made is that you believe the FED is now insolvent. That's just so absurd. The FED prints money out of thin air at NO COST (well maybe it costs a few pennies in electricity) and use the freshly printed money they now own all the mortgages, and even physical foreclosed houses, which HAVE VALUES. Who could have such a good deal, being able to exchange something of zero value, with someth of huge value. I wish I could print my own money and own all the physical houses at no cost to me, and some one call me "INSOLVENT"!!!

You have a fundamental problem understanding exactly what has value and what does not have value. Fiat money has no intrinsic value. Physical Houses cost something to build and have intrinsic values.

Is current housing prices a bubble? The current housing prices have dropped to less than 50% higher than 2000. You will be hard pressed to find some thing whose price has raised less than 50% from 2000. Gasoline price is now $3 a gallon versus $1.15 in 2000. Is today's 3 times higher gasoline price a bubble? Exactly what is a bubble?

Banks are not willing to put foreclosed houses to sell in the market for good reasons. They know the current market prices are depressed and below fair price. They are better off holding to the physical houses, than to sell them at depressed prices and then hold worthless cash.

Let me ask you, Karl: How much is your house worth today, in your own honest opinion, and in current market price. How much is it worth if it is sold at foreclosure price? Do you think the foreclosure price is a fair price? Are you willing to sell your house at foreclosure price? Why not if it is a fair price? If you are not willing to sell your hosue at foreclosure price, then banks don't want to sell their houses, either.

Moving forward, the dollar is doomed, the only safe assets to hold are physical assets. Karl if you don't believe so, immediately sell your house to the first buyer you can find, hoard the cash. Maybe two years later you can buy back a better house at cheaper price, netting you a profit. Good deal isn't it Karl? I advise you do it.

Sep 29 10:45 PM

[Mark Anthony:]

Karl:
Having said that about housing prices, I must emphasize that in NO WAY I am implying that the banking system is healthy or solvent. Absolutely the opposite. I believe every bank is insolvent, but NOT due to reasons you cited, the balance sheet problem, rather due to a fundamental definition what solvency of a bank means: liquidity. If your mortgage lender send you a letter demanding that you pay off your mortgage within the next week, I don't think you have enough liquidity to pay it off. So by that definition you are not solvent regardless of your balance sheet. No one is solvent if that occurs.

The problem is when there is no sound monetary system, there can NOT be a healthy banking system. At certain point of time, which could be close, the Average Joe may decide it is a foolish idea to leave their money in a bank saving account and watch the value evaporate as the dollar collapses. They will want to withdraw their money and put into physical assets. When enough people do this, there will be panic bank runs and banks will collapse.

Sep 29 11:05 PM

[Dialectical...:]

I think it is valid to ask for sources, so don't jump on me for taking issue with one thing you say:

On Sep 29 10:58 PM Karl Liesman wrote:
> Why do you use average instead of median?

An average is the right form a stat. to use when trying to extrapolate a sum from a group of numbers. If I went to Vegas ten times and lost $1 nine times but lost $1million once, using the median (of 1) times the ten trips would suggest I lost $10. Using the average ($100,000) would correctly suggest my real loss was a million dollars. Since he is multiplying the avg. to produce a sum, the average is right. Nothing wrong with the methodology there.

Sep 30 12:17 AM

[Roger C. Wren:]

125 million single family dwellings? In addition to condos and apartments? For a population of about 320 million?

Hard to believe.

Sep 30 02:28 AM

[58robbo:]

i'll clarify what i meant: why would anyone strategically default if they weren't upside down? the answer is that they wouldn't. the strategic defaulters are doing so precisely because they price they'll fetch in the real world for their homes is less than what they owe. if they still had any real equity they'd sell instead of default!

On Sep 29 04:47 PM Karl Liesman wrote:

> Karl says, "Almost by definition, foreclosures only happen on upside-down
> properties."
>
> That is just not true. Read and learn.
>
> www.boston.com/realest...
>
>
> www.washingtonpost.com...

Sep 30 04:08 AM

[Karl Denninger:]

Again: If you fall behind in your ability to pay your mortgage and have positive equity, there will be no foreclosure. Why would you take the credit hit from a full foreclosure rather than sell?

BY DEFINITION the reason foreclosures happen is that you CAN'T SELL because you are upside down. To clear the liens at closing you must BRING MONEY to the table, and you can't. Bang.

This is why, during "ordinary times", the foreclosure rate on prime loans is less than 1% - nearly all homes have positive equity and as a consequence when you lose your job (or find yourself having to move someone else to remain employed) you are able to sell the house and clear the note. More than 1% of the population gets in trouble on a routine basis, but that doesn't result in a foreclosure because the home has positive equity and is sold off, clearing the mortgage.

For those who doubt the severity numbers on loss do some research on what the losses have actually BEEN. Last year's "subprime" foreclosures (the foreclosures that have, in the main, been "all the way through the python" thus far) have had loss severities reported from 40-60%; the most commonly-cited number was right around half. Remember that during the delinquency period property taxes are unpaid and in many areas on a $300,000 house these taxes can be $10,000/year or more. The subprime experience is that losses are about half due to negative equity (which has averaged about 20%) and the other half foreclosure-related expenses, including legal and costs, rehabilitation and marketing.

Many homes (especially in SW Florida) that are unoccupied and in foreclosure in fact have NEGATIVE value. Ditto for places like Detroit. Value losses on many of these homes against the market have been 80% or more with some losses being literal totals; when one adds in legal fees and unpaid property taxes the cash recovered from a foreclosure sale in fact leaves one with a NEGATIVE number. Again, those who doubt this need to come into Florida and have a look-see at some of the unoccupied and foreclosed inventory that is being held off the market - an unoccupied home in this state where the power has been cut off will within months turn into a mold incubator that turns the drywall black and requires a complete gut-out or razing.

Note that The Fed shows total outstanding mortgage balance of $10.392 trillion as of June 09. Also note that in a foreclosure action where the home has negative equity .vs. the first lien RECOVERY ON ANY SECOND LINE AND/OR HELOC IS IN FACT ZERO AS THOSE ARE SUBORDINATED DEBT.

You guys who are claiming that there's "only" $3 or 4 trillion out in mortgages are arguing against THE source of this data - The Fed's Z1 that is issued once a quarter.

Two years and change ago I said that I expected total residential (single-family, not condo/commercial) losses to reach $3 trillion. This was simply off the fraudulent "appreciation" and negative equity exposure on these notes along with a cocktail-napkin guess at what the banks would do (extend and pretend) that would only worsen the situation. We have taken about $1 trillion in loss thus far, and this latest estimate actually comes in low against my "first blush" estimates from two years ago. I'm probably wrong - on the low side - that is, there's probably MORE than $800 billion in remaining losses.

I was laughed at two years ago when everyone said "subprime is contained" and there would be no massive unwind of this mess. Those who wish to argue that it won't be that bad are welcome to their opinions; we shall see who's right in the fullness of time.

Sep 30 08:53 AM

[Michael Clark:]

Thanks, Karl, for another thoughtful post.

The first stage is denial. The second stage is anger. I've predicted that the anger will be directed by the bulls at the bears. The bears will be accused of stupidity, lack of patriotism, cowardice....there will be a long list of accusations.

Maybe we are entering the second stage.

Sep 30 10:33 AM

[Hangdog:]

I think everybody has forgotten about the Kansas supreme court ruling making it illegal for MERS to foreclose on certain houses for which they hold the mortgage notes without those notes actually being transferred. Therefore the 40% loss on a certain foreclosed home proposed by Karl might actually be 100% unless MERS or their buddies can establish locus standii

Sep 30 11:16 AM

[swaps:]

Benranke last week said the recession is over.
Clearly, the housing mess is not.
Reading karl's figures and then noting the opposing comments one thing is clear. The current financial system is too big to manage. No matter whose figures are correct or incorrect, the figures are too large to be easily quantified.
Karl says the remaining losses on mortgages may exceed $800 billion. The privately owned Federa Reserve will undoubtedly respond with a $2 trillion money printing order. The people on this board who are questioning your figures are themselves forgetting the Fed has already fed more money into the black hole than the losses so far because complicated, apparently often fraudulent derivatives created supposedly home anchored financial instruments that exceeded the value of even the over appraised homes.

There was a very informative article on what caused the financial meltdown in an issue of Conde Nast Portfolio last winter. Fraudulent investment bankers and rather dumb financial wizards and monitors were the culprits. Portfolio shut down a few months ago because of financial woes, but I wonder too if the closure was prompted by shadowy forces who want to avoid going to jail.

I think Benranke and the government will do all they can to paper over the bankruptcy of the financial system because in a democratic society usury is the strongest and most subtle form of slave control.

Sep 30 12:16 PM

[artkarl:]

My cocktail napkin tallies with yours.
It just boggles the mind, and such fun it will be unraveling.
SO hard to find a good small bank to park cash in.
There's not enough physical gold around to hedge with.

-Karl Krachenberg

Sep 30 12:44 PM

[Thomas J. G...:]

I would like to add one little piece of information supporting Karl's 12% foreclosure number. I am aware of some short sales in California recently where the bank lost significant amounts of money (25% plus they had to carry the unpaid loan for many months). Short sales don't count as foreclosures but if they involve significant losses they could just as well be foreclosures. So even if a govt' agency never says "12% of houses foreclosed", there still can be significant bank losses going on through short sales.

Sep 30 02:06 PM

[Jasper M:]

Karl,
I am a loyal partisan of yours, but I fear you have gotten at least one thing wrong - sometimes foreclosures DO happen with positive equity, Not because of premeditation, but due to a distracted resident (I will not say owner) failing to deal with the situation optimally. I have seen this, fairly close up, a couple of times. I am not claiming it happens a lot, or even enough to noticeably skew the data. But if it Can happen, it shouldn't be ignored in modeling, at least not without some thought.

Sep 30 03:52 PM

[User 192415:]

WHY CAN'T SOMEONE JUST TELL IT LIKE IT IS!
WE WILL HAVE INFLATION THAT WILL FLOAT ALL HOUSING-
MORGAGES BACK TO THEIR NOMINAL LEVELS. AND IT WILL
HAPPEN FASTER THAN SLOWER....

Oct 01 06:09 AM

[Jasper M:]

On Oct 01 06:09 AM User 192415 wrote:

> WHY CAN'T SOMEONE JUST TELL IT LIKE IT IS!
> WE WILL HAVE INFLATION THAT WILL FLOAT ALL HOUSING-
> MORGAGES BACK TO THEIR NOMINAL LEVELS. AND IT WILL
> HAPPEN FASTER THAN SLOWER....

Because that's Not how it is.
The freeze-up in bank credit, which all the King's horses have been (and will continue to be) unable to micromanage away, means a drastic drop in money velocity. That means the government cannot inflate money supply by adding credit - they actually have to Print reserve note (cash, to you and me). And that is a far, Far slower process than the instantaneous creation of credit some are counting on.
Think about it - if they try something extreme, like just adding $1000 overnight to the value of everyone's bank balance, the inevitable attempt by the public to draw a(n ever increasing) 'comfort level' of cash would reveal the banks don't Have that much cash on hand, and lead to bank runs, wiping out the whole 'value added' and then some.
Deflation ties the Fed to physical printing presses. And the hole they want to fill is so wide, and so deep, it will take them Decades to fill up that way.

Oct 01 02:24 PM