So, the Obama plan to prevent foreclosures. What to make of it?That's all true, but it's not the real point of the bailout*.
Well, the obvious point is that it represents a massive transfer to borrowers from lenders and the rest of us. As far as I can tell, there is no penalty for having borrowed more than you could realistically afford to repay--not so much as a speck of dirt on the credit report. The administration's release talks a lot about "responsible homeowners", but very few responsible homeowners have payments that amount to 43% of their monthly income.
The government needs to put a floor under the price of houses in order to save the banks. Remember that until you pay off your mortgage, the bank owns your house and uses its value as an asset. If the value of your house goes down, that's bad news for you, but a real tragedy for the banks. The value of the banks' assets is measured against their loans and if the ratio isn't above a certain amount, they're declared insolvent and go under.
For the sake of argument, say that YourBank has $20B loaned out for mortgages. That $20B is an asset because it's backed by the value of those houses. Because of leveraging, say 20-1, it can now loan out $400B to businesses and people.
Original YourBank balance sheet:
Assets: $20B worth of houses
Loans: $400B to businesses and people
If the value of real estate drops by 20%, those assets claimed by YourBank are now worth only $16B and they are only permitted to lend out $320B. Too late! The loans have all been made and they can't be recalled quickly. YourBank now needs to find another $4B and fast!
New YoutBank balance sheet:
Assets: $16B worth of houses (and falling rapidly!)
Loans: $400B to businesses and people (who can't pay it back immediately)
YourBank has now loaned out $80B more than it should have and the regulators are on their way over to shut it down!
That's where the bailouts come in. The government can just hand them money (which we did under Bush) or it can make the payments for the fat slobs who bought houses they couldn't afford (Obama's plans) so that house prices don't keep going down due to foreclosure sales.
This is one part of the Obama economic plan that might make sense. We could probably have done away with the whole stimulus package and all the rest and just tried to put a floor under housing prices. We could then wait for the economy to recover and we would be (relatively) OK. Instead, we're going to borrow and print money like mad and spend, spend, spend!
* - who knows, with this crew of dingbats, it may well be the whole point of the bailout. They may be too stupid to realize the trouble they face.
4 comments:
Thanks for the explanation. I just haven't been getting where the defaulting on loans was getting us into so much turmoil and trouble. This one post helps a lot.
Now my question is, if the banks knew that some of these (sub-prime) loans were unlikely to be repaid, why did they use Adjustable Rate Mortgages?
More money in the short run?
captcha: apsia
Jedi Knight, the banks didn't hold on to the mortgages. In fact, it's like a game of "Button, button, who's got the button?"
Mortgages were instantiated by some broker who got a commission.
Case 1: The bank that handed out the cash took the mortgage and turned it into a security (think of buying a stock or bond). That security was sold to an investor. Since the mortgages were bundled, the investors had no idea what they were buying.
Case 2: The bank sold the mortgage to Fannie Mae or Freddie Mac. This is where the government meddling comes in. In the old days, FM would only buy good mortgages - big down payment, good credit scores, good salary from the borrowers. If a bank wanted to make a loan to an unworthy slob, it had to take the risks itself. In order to make homes affordable for the slobs out there, the government changed the rules for FM to buy loans and FM started buying up worse and worse quality loans.
That's how Fannie and Freddie went bankrupt. They were stuck holding tons of lousy mortgages.
The banks made the loans because they didn't think they would end up holding the bag. Also, they made the loans because everyone else was. You didn't want to be the only sane bank making 4% on your capital when every other bank was making 12%. If you were sane, your stock wouldn't go up and you couldn't offer good rates to investors.
Does that help?
My captcha word: "Cultero"! It's the kind of car that John Travolta and Tom Cruise drive.
I don't know which is the greater evil, Nationalizing the banks(both Bush and Obama) or artificially proping up the price of homes (price control). Both are tar babies, we'll have a real hard time getting away from either approach and back into a healthy market economy.
Eh, it's finally sinking in. My hubby tried to explain it to me, but I just wasn't getting it. Give me a person to analyze and I'll be brilliant, but the economy...
Capcha: Slavild: Popular girls name in Norway circa late 19th century
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