Help me understand, please $$$

[pjrose]

Banks and other lending institutions lent money at very low but adjustable rates, with low down payments, to people who may not have been able to afford higher rates or down payments and who may not have qualified under more traditional terms.

When the rates went up, perhaps just 1-2 percent, which doesn't sound like much, many people could no longer afford to pay their mortgages. Mortgages are structured such that most of the interest is paid in the first part of the loan, so a small increase in annual interest leads to a big increase in payment because the payment reflects the increased interest for the entire term of the mortgage. Again, we are talking about those who might not have qualified for the loan under more traditional terms, and who thus might have had incomes and/or assets that may not have had the flexibility to handle the new higher monthly payment, thus there were many loans in default.

In addition, with little invested in the house, because of low down payments, many people just walked away, leaving banks and other lending institutions holding a lot of property. Banks are not in the real estate business, and would need to sell the property to regain their money. Then the laws of supply and demand kick in: lots of defaulted property => lots of supply => lower cost => losses for the banks and related institutions and the larger institutions that invest in them.

 

[Rose Pink]

Thanks to everyone who posted

I appreciate that you took the time to post such thoughtful and informative answers. I appreciate that you were polite to each other and not condescending to me. I know I am not the only one who just doesn't understand how the economy works--or doesn't work. I've just tried to make sure I don't spend more than what is coming in. That is hard to do sometimes. I do pay off the credit card each month. The only loan we have is the mortgage and the house is worth (today at least) far more than we owe. I do worry that the employment may end and we are left with payments to make and no money coming in. We will need a new car in the next few years (just hit 99K on the odometer) and have no savings to pay cash for one. So far, we have been blessed, though.

As Icarus said, we all share in the blame. I think that is because we all share in the greed to some extent. Some of you have been wise but most of us could have done better, I know I could have. I am better off than most, but not as well as I could have been had I been wiser and more disciplined. Ah well, no sense crying over spilt milk. Can't change the past. Must knuckle down and be more reasonable in the now.

What does your crystal ball foresee? Are we going to have a full-blown depression? A global depression? Didn't we learn anything from the one 80 years ago? I worry for my children and grandchild.

 

[Wonka]

Icarus-

I don't think anyone could do a better job of explaining the situation and leaving politics aside. One aspect that you haven't discussed is worldwide lines of credit and the impact. That's been discussed on the tube all day today.

 

[brooklyn-joe]

Kudos to all

Thanks to all of you for raising the issue (thank you, Rose Pink) and presenting the information in a straight-forward manner, without pointing fingers to anyone but ourselves. I'm proud to be a member of an organization where this can happen without name-calling, and full respect given to responders. You all deserve attaboys!!

 

[stevedmatt]

I know I am completely wrong, but could someone tell me why?

If we just let these businesses fail and go broke, wouldn't that make the economy better? Anyone who owes money to these companies would be relieved of their responsibilities, therefore their mortgages. Wouldn't that be a huge help to the economy?

Or... shouldn't we take the money used to bail out companies and give it to homeowners on the brink of foreclosure to help them get on track. This in turn will help the homeowners and the businesses.

 

[Icarus]

Anyone who owes money to these companies would be relieved of their responsibilities, therefore their mortgages.

Are you just kidding or is that a serious question?

No, it doesn't work like that. All assets of a failed institution will be sold to another entity, and then you will pay them instead of the original bank that failed. A loan is an asset to a bank. Chances are the only time you would see any change is if the bank that failed was the one that was servicing your loan. In that case, somebody else will service the loan.

-David

 

[Icarus]

Icarus-

I don't think anyone could do a better job of explaining the situation and leaving politics aside. One aspect that you haven't discussed is worldwide lines of credit and the impact. That's been discussed on the tube all day today.

Thanks for the compliment.

Maybe you could post a summary of that issue if you feel inspired?

-David

 

[stevedmatt]

Are you just kidding or is that a serious question?

No, it doesn't work like that. All assets of a failed institution will be sold to another entity, and then you will pay them instead of the original bank that failed. A loan is an asset to a bank. Chances are the only time you would see any change is if the bank that failed was the one that was servicing your loan. In that case, somebody else will service the loan.

-David

Somewhat kidding. I guess my question is, why can't we let a failing business fail? I understand that the assets would be sold off. If another business or businesses is/are willing to buy these loans at a reduced price, wouldn't that be to their benefit as well as our benefit as a country? I don't understand why we don't just let them fail and be sold off to the highest bidder.

 

[Wonka]

Thanks for the compliment.

Maybe you could post a summary of that issue if you feel inspired?

-David

No thanks. I'm not that inspired. If I see an article on any of these discussions, I'll post a link and let the experts describe the situation of worldwide lines of credit in the current crisis.

 

[frenchieinme]

Here's an example of how it is affecting us...

Here's is a non-political explanation via example of how tis is affecting us in our daily lives. I live in the State of Maine. Voters here have the final say as to how indebted we get to meet certain projects. Maine is holding the right to sell chunks of approve bonds. Rather than spend all at once, the State goes out and sells millions of securities backed by voters'approval to these bonds.

This week Maine decided to do 10 or so projects at a cost of $50 million. Because of the state of the economy, there were no takers for this $50 million. These projects have now been temporarily put on hold. One can not remember when this last occured. This means a trickle down to contractors who had planned on doing this work and also affecting their suppliers and also affecting their workers, etc... Get the idea?

As Icarius stated, the economy is being squeezed by tight credit. This is just a vivid painful example of how it is and can affect you.

frenchieinme

 

[frenchieinme]

Guess who gets saddled with paying...

You said it, our kids and grand kids will be stuck with paying for this no matter which bailout is approuved. It is shameful how one generation could and can harness the coming generation with the paying off of this generation's greed and desire for living for the moment and paying for it l;ater on. Our saving rate is one of the worst in the world. We have become an over consumer generation fueld by greed and instant pleasure. Some people will be working far beyond their retirement age in order to just survive let along enjoy the fruits of a long life.

frenchieinme

 

[caribbeansun]

There already have been a number that have been allowed to fail.

The destabilization of the underlying economy that is at issue. There are more then just the financial institutions that are impacted by such failures - consider the shareholders which include pension plans that own the stock, mutual funds, employees, retirees, etc. Consider the employees and their families and the impact on all of those that are dependent on their continuing incomes. Consider the other financial institutions that bought bundles of the underlying assets that are now devalued creating situations wherein they can't cover their outstanding loans because of the erosion of their capital. It's the macro-economics more than the individual companies that are being considered.

Somewhat kidding. I guess my question is, why can't we let a failing business fail? I understand that the assets would be sold off. If another business or businesses is/are willing to buy these loans at a reduced price, wouldn't that be to their benefit as well as our benefit as a country? I don't understand why we don't just let them fail and be sold off to the highest bidder.

 

[Rose Pink]

It's like fixing the foundation of the house so the whole thing doesn't fall down.

 

[Kal]

It's like fixing the foundation of the house so the whole thing doesn't fall down.

It's very difficult to fix the foundation when not only the house but the whole neighborhood is falling down around us. The fact that you can't get a construction loan or the guys fixing the foundation can't get a construction bond (from AIG) won't even allow any construction to occur.

A true Catch-22.

 

[rapmarks]

Is there any realistic potential for the government to get all or part of this money back in the future?

 

[Liz Wolf-Spada]

Thanks for all the explanations. There are so many terms being used in this crisis that I am printing up much of this to study when not trying to read a screen. Someone on the radio mentioned that in California, part of the problem was that when credit was easy and houses were selling, developers overbuilt and now those houses, along with the foreclosed houses, are sitting empty in this tight credit market, continuing the downward housing spiral. Many developers are now doing there own financing, even more than did it previously.
Liz

 

[Kal]

Is there any realistic potential for the government to get all or part of this money back in the future?

Absolutely! As an example, there might be 1000 mortgages bundled into one package which includes good properties and bad properties. A bad property is when there is default on payment. A good property is up to date on payments. Pull out the good properties and those will continue to return interest. The bad properties still have value but at a lower amount than the loan. Those properties can be sold at a discount, which happens every day with foreclosures.

The second way (which is very likely) is to sell each package at an auctioned rate. There will be a cash return because of the underlying value of the properties, but not at the sum value of all the loans in each package. There will be huge lines of investors waiting to pick up those packages at a low rate then either wait for a good return or flip them at a somewhat higher selling price. Financial houses are selling those properties right now and they are being grabbed up quickly.

The problem is there are so many that the entire process is burdened down by volume. The financial institutions need CASH NOW and can't move quickly enough.

So the big question is will we get $500 or $600 billion back. The feds don't know how to make a profit so that option is left to investors who purchase individual units.

 

[Rose Pink]

a bake sale

Is there any realistic potential for the government to get all or part of this money back in the future?

I caught the end of Wait, Wait Don't Tell Me (NPR) today. The three panelists were asked to give their predictions on how the US would come up with the money. Thanks to the wonderful explanations from tuggers, I actually understood Tom Bodett's answer. Click on the link, scroll down to the bottom, click on predictions to hear the responses.
http://www.npr.org/templates/rundowns/rundown.php?prgId=35

 

[Rose Pink]

It's very difficult to fix the foundation when not only the house but the whole neighborhood is falling down around us. The fact that you can't get a construction loan or the guys fixing the foundation can't get a construction bond (from AIG) won't even allow any construction to occur.

A true Catch-22.

Yes, that is a much better analogy than the one I gave. Kinda reminds me of Hurricane Katrina--we still haven't recovered. Now Ike has hit. Now Kyle is threatening Maine. One financial hurricane after the other.

 

[PigsDad]

Somewhat kidding. I guess my question is, why can't we let a failing business fail? I understand that the assets would be sold off. If another business or businesses is/are willing to buy these loans at a reduced price, wouldn't that be to their benefit as well as our benefit as a country? I don't understand why we don't just let them fail and be sold off to the highest bidder.

I think that is a very valid question, Steve. IMO, the mortgage companies failing is not the big issue. Instead, it is the credit squeeze that is happening. People and businesses are having a hard time getting loans since there is a ton of money locked up in these bad mortgages. It wasn't a problem until the value of the assets (homes) that backed the mortgages started dropping drastically. That quickly changes the loan-to-value, and at a macro banking level, quickly lowers the amount of money banks have to loan out.

That leads to businesses not being able to get operating loans -- their business might be going along just fine, but if they can't get the capital they need to operate, they will then be forced to scale back resulting in layoffs. Then the layoffs in turn can exasperate the mortgage crisis with those homeowners not having a job.

One big catch-22: bad mortgages lead to credit squeeze which leads to unemployment which leads to more bad mortgages.

At least that is my understanding of it from reading and talking w/ others. I won't feel insulted if someone corrects me because I am off base here -- I am still in learning mode on this one.

Kurt

 

[Icarus]

Thanks to the wonderful explanations from tuggers, I actually understood Tom Bodett's answer.

I thought he was going to say that we'll leave a light on for you at Motel 6 when you all get evicted from your homes.

-David

 

[somerville]

What the treasury wants to do is similar to what the RTC did during the Reagan years. They purchased the bad assets of the bank (at a discount), took possession of properties that were in default and sold them at auction. We don't know what the details of the plan are yet, but it involves purchasing the bad debt (at a discount) which will allow the banks and lending institutions to recapitalize.

Until the bad debt is written off, we will continue to be in a liquidity crisis, and very little money will be available for business expansion and consumers.

I am not sure that what is being proposed today is that similar to what the RTC did. All assets obtained by the RTC were from failed thrifts. The financial institution was closed, the RTC paid off the depositors and then liquidated the institution's assets.

As I understand the Treasury proposal, Treasury will buy mortgage assets at a discount. If the sales price is less than what the company is carrying these assets on its books, it will result in an immediate loss. If the company does not have sufficient capital to cover the loss, it will have to raise capital, or it may become insolvent and end up in bankruptcy, or in the case of an FDIC-insured financial institution, receivership. With the Treasury proposal, the thought is that with the hard to value and unmarketable securities off its books, someone will come in and recapitalize these companies. That is an unknown, and then the next question is will it be US or foreign firms that come to their rescue. At this point, it is my understanding that the US Treasury will not be injecting capital into companies selling them bad mortgage securities.

 

[Kal]

..One big catch-22: bad mortgages lead to credit squeeze which leads to unemployment which leads to more bad mortgages....

Milo Minderbinder WE NEED YOU to cut this deal!!!! And all we've got is Yossarian in the tree.

 

[Kal]

...then the next question is will it be US or foreign firms that come to their rescue. At this point, it is my understanding that the US Treasury will not be injecting capital into companies selling them bad mortgage securities.

The loss of the "uptick rule" in July 2007 (which was established after the Great Depression) had been a major cause for financial institutions being destroyed in the stock market. There is only a limited time before the ban on short-selling financials will end. We absolutely have to restore the uptick rule to level out the playing field so financial institutions are not exposed to otherwise destructive short selling of their stock in part due to the loss of capital.

 

[MULTIZ321]

Could the Uptick Rule Save Us from Financial Terrorism?

No Uptick Rule: Convenient Scapegoat?

The Uptick Rule and its Pilot Period


Richard