A house was purchased a couple of years ago for $100,000 and got a $100,000 mortgage. If the homeowner sold it today, they could get about $75,000. The $3,000,000,000,000+ question is, how much is the “asset” worth?
Scenario #1: Every mortgage payment has been made on time.
- The homeowner knows that their house is worth $75,000, even though, they owe $100,000.
- Under current rules, the banks and the mortgage backed securities which own the mortgage, are required to say the house is worth about $75,000. Since banks have strict capital requirements by the Fed (unbelievably complicated), writing down this asset by $25,000, generally, means the bank will have to raise capital to make it up by selling about $1,000 in new stock or attracting subordinated debt (or other methods) which may be really hard to do when your stock is in a spiral.
- Meanwhile, investors in the banks and the mortgage backed securities which own the mortgage, buy or sell based on their guess whether they think the companies are telling the truth on a timely basis, and, generally, don’t believe anything leaving the stock and securities prices in the toilet.
- The banks, Wall Street firms, the Treasury and the Fed want to value it at $100,000 and have our government guarantee that it is. The mortgage is performing as if it is worth it is worth $100,000 and if held until maturity it would be, therefore, it is.
Scenario #2: The mortgage is behind, but not technically in default.
- Same as above.
Scenario #3: The mortgage is in default.
- The homeowner is probably living somewhere else, thieves have gutted the house for appliances and copper and the house is no longer inhabitable and has a market value of about $40,000.
- Under current rules, the banks and the mortgage backed securities which own the mortgage, are required to say the house is worth about $40,000, but they really don’t know what the market is or the condition of the house and would likely just take their time reporting an optimistically guess to the value. When the Fed finally finds out, the bank would be required to write down the asset, and, if the bank had enough of them and can’t raise enough capital, the bank would become insolvent forcing the Fed to “nationalize” it or force a merger with another bank to big to fail until we run out of banks.
- Investors left the house, the bank and the securities long before the former homeowner and isn’t planning to come back until something fundamentally changes.
- If the bank was lucky enough to be one of the 13 banks with more than $100 billion in assets, the Treasury and the Fed (announced yesterday – see: Giethner’s Remarks and the new FinancialStability.gov website) would give the banks “a carefully designed comprehensive stress test” and mortgages, or, in this case, the asset, would be purchased for about $75,000 by the Public-Private Investment Fund they call the “Financial Stability Trust” which they plan to capitalize with $500,000,000,000 of tax-payer money. The banks and the mortgage backed securities which own the mortgage would be out about $25,000, but no longer have the mortgage and could go back to doing whatever really big banks and and really big mortgage backed securities do.
- If the bank was one of the 9,446 small banks that haven’t yet been forced to merge with one of the lucky 13, the house would eventually be sold for about $40,000 and the bank and the mortgage backed securities which owned the mortgage would be out about $60,000.
Now if my simple answers made this seem incredibly complicated, which it is, you might be wondering why the Fed and the Treasury didn’t just tell the banks to re-work the mortgages, send the government the bill (let’s use the term stock so it could be sold later when things are better), so consumers could stay in their homes? Me, too.
Here’s the simple math:
- Total US Mortgages: $12 trillion
- Mortgages that are 60 days or more late: 4% or $480 billion
- Cost to re-work/write down mortgages by 30%: $144 billion
Even if my figures are off by 1,000 per cent, the cost would be far less than what we are doing, but this is the path we’ve gone down and is better than letting the house of cards we live in, fall on us.