Thursday, January 17, 2008

Deconstruction of some dumb platitudes

Subprime Losses Are Big, Exaggerated by Some: John M. Berry

In the comments section, I will deconstruct all this chaps points. @Drewster - if you don't like this or understand its relevance to Houses/Housing Markets - I don't care.

Posted by lvmreader @ 04:42 PM (1231 views)
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8 thoughts on “Deconstruction of some dumb platitudes

  • As the U.S. savings and loan crisis worsened in the 1980s, analysts tried to top each other’s estimates of the debacle’s cost to the federal government.
    Much the same thing is happening now with losses linked to subprime mortgages, with figures of $300 billion to $400 billion being bandied about.
    A more realistic amount is probably half or less than those exaggerated projections — say $150 billion. That’s hardly chicken feed, though not nearly enough to sink the U.S. economy.

    This is a different world to 1998, let alone the 1980s. In the 1980s, the global markets were not particularly well connected and IT was in the stone ages. Goldman Sachs had trouble raising $300 MILLION to help bailout LTCM in 1998. $150 BILLION is unheard of.

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  • A loss of $150 billion would be less than 12 percent of the approximately $1.3 trillion in subprime mortgages outstanding. About $800 billion of those are adjustable-rate mortgages, the remainder fixed rate.
    Subprime loans represent about an eighth of the value of all U.S. residential mortgages. In the S&L crisis, Charles A. Bowsher, director of the Government Accountability Office, topped everyone’s estimate with $500 billion, though that dubiously included the cost of interest on money borrowed to cover actual losses of $160 billion. That’s about $260 billion in 2007 dollars.

    Well CDOs only need 10% defaults to cause complete default failures. What happens to prices as things are forced to sell – yup they go down. This is called a feedback loop.

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  • There are two reasons why the losses aren’t likely to be so large.

    First, the mortgages are backed by collateral, a house or condominium, and in a foreclosure a home typically retains significant value. When it is sold, the lender often will get 50 percent to 60 percent or more of the loan amount after foreclosure expenses.

    Second, most subprime borrowers aren’t going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

    You don’t think that all these house being forced onto the market won’t drop in value?
    50% or 60% of what? The bought price or the current market price? Do you understand basic market dynamics?

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  • To reach a $300 billion loss would require foreclosures on about half of all subprime mortgages with a 55 percent recovery upon sale of the property. And a $400 billion loss would take about a 60 percent foreclosure rate with recovery of about half the value from the sale.

    Are you insane? If just 20% default, the effect on the market would be chilling, coupled with the higher interest rates charged to the “survivors”. The survivors would be paying more on a depreciating asset. More would choose to simply walk away.

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  • This all depends on the what happens next, based on the large portion of the economy (both here and the US) that has fed on equity withdrawal then if we enter a recession (and the chances are we will) then we will have entered a feedback loop.

    Then such projections as described above will materialise and $300 Billion losses will be exceeded.

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  • One of the issues on the S&Ls was that the Us government contributed via the FDIC to the insured losses. I.e. they provided insurance up to $100k per deposit for 100%. They then tried to get some of this back via for example the Accountants. However here we are talking about corporate banks taking a bashing, in the front line. I am sure their reaction will be different and deflationary as opposed to the governments reaction in the S&Ls. Having said all that i understand that the municipalites may have been involved in these investments too – so a government / state bailout mightbe on the cards too. lvmreader this is your area, have i understood it correctly?

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  • @lvmreader: This is a good article, highly relevant. The journalist seems a bit too upbeat – many problems remain to be found. There are derivatives such as credit default swaps; there is the carry trade yet which could unwind; and the stockmarkets are showing serious signs of weakness, with most western stockmarkets distinctly lower than six months ago. So basically lvmreader, I agree with much of what you say!

    I think the elephant in the room is rising petrol prices and Peak Oil. Many of the Pleasantville suburbs with their McMansions may be almost entirely uninhabitable in a world without cheap oil. Although we Brits complain about the price of petrol rising 40% in five years, in America the price has risen 100% over the same period. Suburbs which just a few years ago were easily commutable now appear completely ridiculous. The housing boom-and-bust has been most pronounced in the sprawl areas such as Arizona and Florida. Conversely, densely populated areas with low per-capita oil consumption (such as New York and San Francisco) are still holding up well. If most of the new mortgages and new building has taken place in the car-centric suburbs then the defaults could yet worsen.

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  • European-bear says:

    I think it is quite a good article and the point is that there is always an assett to be sold when a mortgagee defaults. Yes it will depress the price but then recovery of say 55% of the loan may not be so unrealistic. Reported on this blog recently was the guy from Florida who had $100,000 per year income, took out a monster subprime loan of £1.8 million fixed at 1%. needless to say the home was repossessed and it fetch $1.3 million in forclosure…a loss of 28%…..in terms of % well within what the article is mentioning (but then a loss of $500,000 on one property is a big hit)…..I still think the US economy will not go into meltdown and will survive maybe after a recession which will not be so severe. However the UK has bigger problems, but is behind in the cycle….

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