RickRussellTX

Bailouts: The Moral Imbalance

I'm going to tease some truth out of a response that I otherwise don't agree with:

"These mortgages are worth 95 cents on the dollar if held"

The question is: is this actually true? That actual mortgage default rate may turn out to be about 5%. I've seen competing figures of 3.75% to 4.5%, but the worst may not yet be behind us, so let's assume 5%.

In principle, then, 95% of the mortgage assets can be valued at their stated value, while perhaps 5% will have a value below their stated value. In some case, far below their stated value, but in most cases, perhaps 30-70% their stated value, since the properties will be sold and the proceeds divided among the mortgage-backed security holders.

However, that assumes that home prices stabilize. If they do not, won't defaults go up? Few people will be willing to pay for a $500000 mortgage on an asset that is worth $300000 or less, and for them it may make sense to walk away, deal with the credit problems, and get back on an even footing in 5 or 7 years. I have a relative who defaulted on a mortgage -- BADLY, by just walking out and refusing to check her mail -- and she repaired her credit and was offered a new mortgage in 4 years.

The fact that young wage earners are essentially priced out of the home market in many regions is a suggestion that liberal mortgage policies (and let's face it, fraud) created an artificial elevation in home prices. Home prices are directly related to mortgage rates and liquidity. If rates go up or liquidity is permanently reduced (or both) then home prices will truly adjust downward.

That's why these assets are so toxic. Sure, 5% looks like a realistic number now. Realtors I've talked to say that about 30% of home recent buyers are in bad mortgages *right now*, at current home prices. What if the final number is really 50%?

Of course, we may not have a choice. The person who made off with the money -- and the person who was least culpable in this disaster -- was the home seller, who didn't commit fraud or put anybody in a position of taking on a bad mortgage.