Thursday, August 21, 2008

Mortgage math gives you a headache.

Wall Street Journal
Reliving the S&L Meltdown
August 20, 2008; Page A17

It was the worst of times -- or maybe not so bad. Such was the tale of three conference calls. Merrill Lynch sold $30 billion of subprime mortgage -related debt to a hedge fund for 22 cents on the dollar. Does that mean the houses underlying these debts (assuming an improbable 100% default)are worth only one-fifth of what owners paid for them? Whereas Freddie Mac and Fannie Mae avoided any big writedowns of their dodgy "Alt-A" mortgages, on grounds they don't need to sell these to any hedge funds and will hold them to maturity, when they will have paid off. So Merrill's houses are worth 22 cents while Fannie and Freddie's are worth a buck?

I'm guessing not.

The article does go on to say that the truth is probably somewhere in the middle, and if you have been reading this a while you know that the equilibrium calculations I charted and graphed for you showed that the prices of homes would have to fall only about 40% or so off their highs to stabilize. That would mean more like 55-60 cents on the dollar instead of only 22 cents. Not that losing 40-45% of the value of your home is great or anything, but it sure beats losing 78%. Merrill Lynch had to sell their holding at a great discount just to get rid of them. A bank that holds onto their mortgages and doesn't try to sell them on the secondary markets will, in most cases, be better off. Dumping more properties on an oversaturated market will only guarantee home prices fall even further. And really, it's high time we returned to a more historic model of home purchasing, where the local or regional bank gave you a mortgage and held onto it until you paid it off instead of trying to spin more profit out of it on the securities market.

In fact, a lot of our economy needs to get back to basics, and even Merrill Lynch agrees.

Internation Herald Tribune
Long period of frugality needed for the U.S. economy
By James Saft
Published: August 20, 2008

David Rosenberg, the U.S. economist at Merrill Lynch in New York, has three conditions he is looking for before he becomes more positive on U.S. stocks: a rise in the personal savings rate to about 8 percent; a decline in the number of houses on the market to about eight months of supply; and a big drop in the amount that debt payments sap from American household budgets. The good news: All three of these conditions would only represent a return to historic norms. The bad news: The economy is a long way from its historic norms. Interconnected market bubbles, first in stocks and then in housing, convinced Americans that they were richer then they were, and that they could borrow and spend freely without having to save much.

That frugality we need is going to have to be a result of relocalization of agriculture and manufacturing, rejection of instant total gratification and the consumerist mentality, rejection of debt except for home mortgages and business start-ups, acceptance of mass transit and community cooperation, and a return to a more sustainable household economy.

Frankly, I'm not holding my breath, but it's still possible - at least for now.

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