P. Kalven

Why Banks Write Down but Don't Sell Subprime Loans

The basic problem is defining what the subprime in a given mortgage was; was it equity on a debt to equity basis? Was it interest rate? Was it a combination of both? Was it extended amortization 50 years rather than 25 or 30? All those things determine the book value of the mortgage before discounting.

All those factors play into the value of the mortgage. However assuming the mortgage was current for part of its life, even at $0.55 on a 6% $250,000 mortgage in a sale today, if that mortgage is in its fourth year and defaulted within the past 12 months, the bank still has made $0.77 recovery before cost of sale when you take into account the three years principal and interest for the none default period of the mortgage.

If there is in fact even the smallest of owner equity left in the $0.55 equation, the bank does better. The point is the bank will do better than $0.55 before expenses, which I suspect are also part of the $0.55 book value calculation on the part of the bank in determining the value of the mortgage before sale.