Vikram Saxena

Ten Bear Market Phases, Current Edition

Mish:

I find your analysis interesting, since it often highlights the negatives which are often ignored. But the spin you put on the numbers is nothing but scare mongering, bordering on the line of unethical conduct.

A few months earlier, you had a blog post about AAA rated bonds having large defaults and suggested that it was a Titanic about to sink. What you failed to mention was that the market was already treating those bonds as junk they were already trading at anything between 20-50c/dollar. For people who trade them their AAA rating was meaningless.

The current post has a link which claims:
". Of the $6.84 Trillion in bank deposits, the total cash on hand at banks is a mere $273.7 Billion. Where is the rest of the loot? The answer is in off balance sheet SIVs, imploding commercial real estate deals, Alt-A liar loans, Fannie Mae and Freddie Mac bonds, toggle bonds where debt is amazingly paid back with more debt, and all sorts of other silly (and arguably fraudulent) financial wizardry schemes that have bank and brokerage firms leveraged at 30-1 or more. Those loans cannot be paid back."

Your inference is that all the loans made out by banks are bad loans and the financial system is on the verge of collapse. This is nothing but scare-mongering.


A vast majority (at least 90%) of Americans pay their mortgage on time. Commercial real estate, in spite of the prognostics of doom, is holding up reasonably well. Further real-estate, even a depressed market has an intrinsic value: the replacement value. People will continue to need homes and the collateral in place is not worthless. Even in the places hit with the biggest defaults, the liquidation value of homes is rarely if ever below 50% of the high water mark; more often than not homes sell at 60-80% of the high water mark. And not all the defaulting homes have zero equity; nor were all bought at the peak of the market. And by the way, the best run bank will go insolvent, if there is a run on the bank and everyone withdraws their deposits.

REBEL: I disagree with you on government intervention.The banking system can tolerate large losses as long as their magnitude is known; what it can tolerate is uncertainty about losses which leads to irrational and illiquid markets. We need a RTC redux to buy and hold properties at their liquidation values and then sell them once the market recovers (inflation will help that happen sooner than you think). It is easy to talk about tax-payer money being misused but if you consider all the ways our politicians spend our taxes, a housing bailout is going to be universally useful in propping up the US economy and our financial system. The cost of inaction when measured across all metrics (fear/uncertainty crippling lending, weaker dollar, higher commodity prices and inflation, falling paper asset pricing, lower economic growth and higher unemployment) is going to be a lot more than what backstop which the Federal government puts to put a floor on the housing mess. Remember unlike much of other government spending, the government is getting real assets with real utility out of this spending, and helping almost everyone in the US.

A Government Rental Agency to Mop Up the Foreclosures

Negative Carry:

Markets tend to overshoot in either direction. In case of housing the effect is not just on investors and traders but your average Joe trying to earn a honest living. That is not good for anyone except for someone betting against US economic prosperity.

A bulk of subprime loans went to lower income people in lower income neighbourhoods. After you remove 43% of the appreciation, you are coming close to replacement value of the home (i.e. the cost to construct). These are not expensive homes or MacMansions. Many times these are homes bought by unsophisticated first time buyers who never thought they could buy a home; they are also dominated among minorities.

What I am trying to propose is to ensure that the markets come into an equilibrium sooner than what the private sector can bring them. Further by putting a floor we ensure that negative psychology does not destroy the world's confidence in US issued assets.

We do need to fix a lot of things including our trade balance and budget imbalance. We also need to take the excess out of housing. However letting the pain in housing linger on for longer than necessary is not the way to do it. Neighborhoods need to be preserved.

A Government Rental Agency to Mop Up the Foreclosures

I do understand the fear of abuse of a system with the government involved. However, one key difference between the past and the present is the role of the servicer.

The servicer handles the foreclosure but has little or no skin in the game. They have very little incentive to get the most out of the foreclosure process. The bank who had a vested interest to recover the most principal is no longer in the picture in most cases. This is especially true for sub-prime loans which were the first to be off-loaded in the securitization market.

The REO sale managed by the servicer is open to abuse and bid-rigging by the vulture investor and the servicer managing the sale. The huge number of foreclosed homes in the market also means that it is going to be a vulture's market to pick; scarcity of buyers means that the fire-sale price would be hard to question.

A government sponsored agency, working with local community members, can insert some semblence of oversight in the process.

There are pros and cons of everything but clearly the market has failed to resolve issues. It is time to consider alternatives. Investors betting on a doomsday scenario may not like but Main Street needs it.

A Government Rental Agency to Mop Up the Foreclosures

Rong: Thank you for the link.

Negative Carry: What you need to understand that a bulk of the mortgages are not held by 'banks' any more. They are held by a virtual entity called trusts which then sell the bonds by backed by them. There is no bank to make a call to sell; there are just servicers who have very little skin in the game.

It is likely that the liquidation will be really depressed values. However unlike other markets liquidation of homes at distress values has a cascading effect on the overall national economy. It affects all other homeowners in the area. It affects mortgage rates. It affects the confidence of investors and consumers.

Measured government intervention is going to be good for a majority of US citizens; the only people who are will get a slightly less good a deal will be the vulture investors and people who are short US assets. I think they have already had their bear run; time to help Main Street.

A Government Rental Agency to Mop Up the Foreclosures

Negative Carry:
The issue with the foreclosure vultures as you call them is that the process will take too long and be too painful.

Foreclosures result in a negative spiral of falling home prices and blighted neighbourhoods. Lack of confidence in the asset pricing environment means that availability of credit will be even more difficult (perhaps even for the vultures).

RMC is role is to manage an orderly mop-up in a quicker manner. Once RMC organizes a bundle and puts a back stop price, the vultures are more than welcome to bid on it. The vultures are likely to pay a bit more than what they would otherwise; they can also not cherry pick the best. But the overall economic effect of a back-stop will be positive.

A Government Rental Agency to Mop Up the Foreclosures

www.fdic.gov/bank/anal...

has a discussions on the costs involved.

The problem with RTC was initially it was auctioning off assets at fire-sale price. Once it started going in equity partnerships, the return on equity was positive.

"However, the public-sector losses were
reduced by $4.5 billion in equity held by the RTC as
of year-end 1999.22"

What I am proposing is a way to prevent a fire sale auction of assets which will have a spiralling effect; an equity based partnership in real assets is likely to return positive returns over a decade. As the dollar revalues to its true global value, the nominal dollar prices of US assets will stabilize and grow.

A Government Rental Agency to Mop Up the Foreclosures

Negative Carry:

1. It will help to read more about how the Resolution Trust Corporation, a government sponsored agency helped stabilize the makets after the S&L crisis. It also earned a profit for tax-payers; now when was the last time the government earned a profit for tax-payers?

2. What we are seeing is a fat-tail event. Something which has a very low probability of happening but can happen. The negatives of such events are well known; what people tend to forget is that after the extreme reaction, the entities left behind profit a lot.

3. The private sector is frozen right now. It needs some direction especially since securitization means that the stake-holders are not local but spread all over the world. That is why the government needs to act. All RMC needs to do is to get the process rolling, aggregate the distressed properties, and provide a back-stop. If the private-sector can find a solution the role of RMC will naturally be reduced. Its primary purpose is to instill confidence.