The New Bank Math: Who Cares About Insolvency?
January 29th, 2009By David Goldman
Here’s how it all adds up: There are about $3 trillion of non-agency mortgage-backed securities outstanding. For the sake of simplicity, let’s say that 65% are so-called AAA’s, and all are selling around where the ABX index is selling, or 35 cents on the dollar. That’s about 35% times 65%, or $682.5 billion of market value. The banks buy all of them. Over time, half of the non-agency (not guaranteed by the federal government) mortgages default, and the houses sell for 50 cents on the dollar (which is where the market seems to be clearing). With recovery costs, etc., the securities ultimately pay 75% of face. The $682.5 billion investment is worth $1.4625 triillion, or an increment of about $800 billion. That’s roughly what the banks have to write off this year.
That’s how the banks replenish their capital, provided, of course, that all the hedge funds and other prospective investors don’t get any. In fact, there’s plenty of other cheap paper out there, including $2.8 trillion of asset-backed securities and $1.3 trillion of Collateralized Debt Obligations. And if that doesn’t work, there’s the good old curve trade: with funding at 0%, banks can buy agency MBS and clip the coupons.
The trick is to keep asset prices low enough for the banks to buy it on the cheap, which sadly means bankrupting most of the hedge funds. Of course, the banks already own a ton of devalued paper, and a bit of creative accounting (of the sort proposed variously by the Group of 30, by Deutsche Bank’s Mike Mayo, and others) is required to paper over the insolvency of the system. The banks, as Goldman’s analysts said, becoe a public utility.
To get the securitized asset market moving again, first you have to find a home for all the miserably devalued securitized assets out there.
January 29th, 2009 at 4:13 pm
David,
There needs to be a RTC like structure that purchases the securitized assets etc. Then the government will have the ability to restructure the underlying mortgages which will act as relief/stimulus to the beleaguered home owners. This relief may also add support to home prices and begin to stabilize the housing market. It needs to be done and swiftly.
January 29th, 2009 at 5:30 pm
I’m not sure you want to do it that way. An alternative is, get the market transacting at whatever price it will clear (50 cents on the dollar seems to be the floor for home prices). Eliminate capital gains tax on homes, including second and third and fourth homes, and homes owned for speculation by corporations.
January 29th, 2009 at 6:27 pm
I don’t disagree with you but with demacrats in the control I believe there is a higher probability relief will come via subsidies to homeowners versus tax cuts. Thanks for your response David.
January 29th, 2009 at 8:06 pm
Hard to tell what happens next. I was worried about cramdown but it appears that Obama quashed that. Congressional Democrats will talk all kinds of relief, but Obama seems too smart to do anything that will have systemic consequences.
January 30th, 2009 at 12:46 am
Why would the banks want to buy more of what they already have plenty of? Troubled assets? As for lying, setting aside the fact that the whole financial system is based on lies and deception, well, everybody pretty well knows they would be lying and I suppose its a matter of psychlogy. Whether to play along with the lie, as investors have in the past, or to call a spade a spade because you could damned well get speared by the lie, as recent history ha shown.
February 1st, 2009 at 8:39 am
Epmccreary, your point is well taken, and I just posted an item that addresses it.
January 14th, 2010 at 9:16 am
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