This is a completely non-macro way to look at things. If one bank forecloses on a property that is not underwater, you don’t have a problem. The bank can quickly sell the property and make its expected profit. If tons of banks have to foreclose on tons underwater properties in a depressed market, a lot of banks aren’t going to make their profit, because the property values aren’t high enough for them to recoup the loan. And as more foreclosures pile up, more properties stay on the market longer, and since banks aren’t property management outfits, these properties have a tendency to decay and lose even more value before they can be sold. If that becomes a fixed trend in the economy, then the banks are going to lose their paper wealth whether you or I like it or not. And given the hideously long lag times between default and foreclosure, we have every reasons to suspect that this is becoming an embedded trend. You can either let the banks sit on foreclosed properties and shaky mortgages pretending they are worth something more than they are, or you can just slice through it and force a reevaluation. But unless property prices recover to their boom levels, the banks are going to have to eventually take a haircut, regardless of what any of us thinks.
The free market would determine the price that Buffett (or anyone) would pay for new stock in the recapitalized banks. Note, BTW, that Buffett did in fact recently invest a large sum in Bank of America, a bank whose solvency was in question.
In a terse (but evidently over-terse) effort to make the likely result clear, I wrote “i.e. by selling cheap shares.” Your remark implies new investments would not be available at any price; an implication which, if true, admits that the banks are insolvent and are already being propped up by governments.
We’ve already had as many different opinions as participating Dopers in this thread, but very roughly the views can be bunched into three categories and summarized as follows:
The present situation is free-market capitalism at its best. The mortgage crisis is transferring wealth from stupid Joe Citizen to rich bankers, as God intended. If the crisis drags out for another decade, no problem: it will be an exquisitely beautiful demonstration of the Principles of contract sanctity, caveat emptor, and creative destruction.
Banks are in danger due to bad loans, but rich bankers aren’t to blame. They must be kept whole with government help: taxpayer bailouts, homeowner evictions, etc. Whenever government money is needed, divert attention by prattling about the virtues of laissez-faire.
Banks are in danger due to bad loans, and can be made solvent through ordinary recapitalization, although existing stockholders may lose value. The regrettable deregulation excesses of the last few decades should be reversed to avoid a replay.
Put me down in category 3. YMMV.
I’ve never heard of this. Can you describe more about this and give examples?
Actually a key point is that real estate has usually been such a solid asset that it is one of the rocks on which the house of cards is built. The scheme outlined in the OP is a plan to dynamite that rock.
You seem to be confusing yourself. **dracoi’s **post was based on the OP’s hypothetical in which banks’ assets have been eviscerated. Quite how you manage to leap from that hypothetical to a conclusion about the banks being insolvent already is a mystery.
I assumed OP had accepted my modification:
“One could even structure revised mortgage contracts so that higher debt could be reimposed after several years if/when housing markets recover.”
In any event, if investors judge a $400,000 mortgage on a $300,000 home to be worth only $300,000 who is doing the “evisceration”?
I shouldn’t try to pretend the issues are simple. I’ll admit that in reaction to oversimplifications by others in this thread, I may have oversimplified in the opposite direction.
However the fact is that banks are being propped up by government action and it is annoying to hear people ignore this and applaud laissez-faire capitalism, when without government action, many of these banks would already be shuttered.
I don’t have a mortgage but I do have savings. Does you plan also include devaluing my hard-earned money in the bank to ‘sensible’ levels as well?
I have no idea why you think this makes your comment on which I commented make sense. The fact remains that you can’t leap to a conclusion that banks are already insolvent by assuming that an unimplemented hypothetical posed on a message board which would make banks insolvent has actually been implemented.
Further, your modification is I think unworkable. Let’s say per the OP as modified by you the value of houses was somehow magically reduced (how does that happen anyway?) to something “sensible” and my mortgage forcibly reduced by law to something less than that new “sensible” value, but with a contract that said that if the value of my house went up I suddenly had a higher debt to match. I would immediately sell that house and pay off my mortgage, so that I didn’t have an automatically inflating debt hanging over me.
What investors are you talking about? The OP proposes that the value of housing simply be reduced by some sort of fiat. The OP is not saying that investors do not currently value the house at it’s current value. Quite the opposite: it seems to be a complaint that market prices are too high. Are you sure you understand the OP?
It is true that the details of such a scheme would be difficult. One possibly workable solution I’ve seen proposed would be for a mortgage moratorium period during which lender/homeowner could have, temporarily, an owner/renter relationship.
in my posts I deviated from the GQ rule of answering OP’s question to instead make the crucial points. I’ll reiterate these:
It is in no one’s interest to have a wave of homeowner evictions. But I think evictions and home vacancies are now at record levels in U.S.A.
The way to restore confidence in the banking system is by increasing capitalization, not by doctoring books. The reason recapitalization is not pursued is that it would adversely affect the paper wealth of influential rich people.
Ignoring whether my comments have been responsive to OP, do you agree with these two points, Princhester ?
Your questions are far too loaded with debatable concepts, political assumptions, ill defined terms and value judgments for me to answer them. At all, probably, let alone in GQ.
Time Out you two!
I think SEPTIMUS believes some banks actually are insolvent, in the real world, separate to this discussion. I’m inclined to agree. Take RBS, HBOS and Lloyds in the UK: government owned now as deemed “too big to fail” in 2008. Surely the need for this injection of liquidity wouldn’t have been necessary if these banks were solvent?
Also, you are correct here PRINCHESTER:
Whilst I take your point that there is massive oversimplification in this thread (I did state at the start that this was an ignorant post with little/no understanding of economics) I’m inclined to agree with SEPTIMUS that most replies to this aren’t tackling the question of capitalism & paper wealth and if the MODERATORS are happy for the conversation to digress from my OP then I’m interested to hear responses to that point…
You assume banks suddenly deprived of mot of their capital asses, possibly underwater themselves, would be able to sell enough shares to recapitalize enough to meet the reserve requirements. All the banks. All at once…
The assumption there are enough millionaires and billionaires waiting to dump their money into stocks of banks that probably will not turn a profit for a very very long time… Is a big leap of faith. Odds are investors will be heading in the opposite direction, investing in eal wealth that is as removed from this artificial banking crisis as you can get.
Maybe the pension funds and 401K’s and other mutual funds can invest in these shares? Oh, wait, most of their free money disappeared when the bank shares they currently hold went from hero to zero.
Is what the OP is stating a subset of devaluation? When a country devalues its currency, it’s across the board. Then, when I looked up “devaluation” to make sure I knew what I was saying, I came across “redenomination” – a new dollar is the equivalent of a thousand “old” dollars, but is then treated as $1. Might that be a way of doing what the OP proposes?
The value of the housing on the open market has, and should have, precisely nothing to do with whether or not a given purchaser can afford it. The idea that housing was important as an investment is one of the more pernicious concepts which gave rise to the bubble.
I expect people to use the same financial hjudgement that everyone should use. If you want to find out if you can buy something, the first step is to look at your finances and ask, “Can I afford this?” If you want to invest in something, then you look at different criteria. But buying a house to live in should not ever be treated as an investment decision, for reasons which can be generally summed by saying, “People should act incredibly stupid to avoid feeling mildly stupid.”
See above. The housing market doesn’t matter and should not matter, ever, period, to the individual loan. What you would really be doing is handing out wealth to people who bought more than they could afford.
Forcing banks to recapitalize is a bad idea. For one, not all banks are public. For another, the banks that need more money are the ones [people, including governments, don’t want to put money into. It doesn’t really matter how cheap you make the shares because people don’t buy because shares are “cheap”. They buy because the share price is a good investment, which they won’t be if your plan went through. Finally, if you make the bank a worse investment, it’s not going to be made healthier by the addition of more capital.
You can’t conjure up wealth by magic, and trying to shove money around the table in the hopes of getting wealth is magic. All you wind up doing is favoring a few lucky bastards while screwing up the game.
What is the incentive to buy shares at any price?
The price of stock is loosely based on a combination of the value of the company’s current assets, and the expected value from future earnings. In the “solution” you’re proposing, the government has just slashed the bank’s current assets (by adjusting the mortgages) and has therefore also slashed the bank’s future earnings. Furthermore, the government has set a precedent: banks only own any assets as long as the government tolerates it. So now there’s significant uncertainty about the value of the already-reduced assets and earnings.
Yes, there are people who will buy in at some cheap stock price… but they’re not going to buy in at a price that will benefit the banks, not in that scenario.
Furthermore, I think you’re forgetting what the rest of the market will do. If BofA announced massive losses for last quarter, and revealed impaired assets (i.e. worth less than previously thought), what would happen? There’d be a massive sell-off in the market.
So your scenario is like a triple death stroke to the banks:
- reduce their current assets, then
- force them to recapitalize by selling “cheap” stock into a market that
- is already crashing as shareholders try to unload the existing stock.
Would you buy that stock? If not, why do you think anyone else would?
For the record, I am not stating that banks are already insolvent. (Not as a whole anyway. I am sure we can point to individual examples that are more troubled than average.)
It wouldn’t necessarily have to be all at once. Buffett’s company just put $5 Billion into BofA. Money is there – FRB programs have effectively injected more than $2 trillion of new money. Finally, the Government can be the share-buyer of last resort – why not let the taxpayer share in the profits when the banking industry recovers?
The idea is to restore confidence and liquidity. When I wrote “… if investors judge a $400,000 mortgage on a $300,000 home to be worth only $300,000 …” and Princhester asked “What investors” I felt a key point was being overlooked. Real investors in the real world do value those $400K mortgages at $300k so banks can’t sell them without hurting their balance sheets. The problem isn’t lack of investment money; it’s paralysis due to low confidence and lingering fears of insolvency.
In a thread like this, we’re not going to come up with a detailed plan to submit to Congress. We can hope to agree on some general principles. I’ve proposed two principles. OP proposes, as a principle, that homeowner monthly payments be reduced to the market values of their rents/mortgages. That’s a logical principle we can strive toward, though the details will be very difficult.
A principle I normally strongly support – the sanctity of contracts – is one that needs to be overridden in times of great crisis. It sounds like some Dopers don’t accept that.
Another important and relevant principle that is hard for some Americans today to accept is that government coercion is often appropriate. (An amusing aspect of right-wing hatred for government coercion is the story of George W. Bush’s successful venture as a businessman.)
If you do that, people still owe as much as they did - the way to express it simply has less figures.
Changing from Lire and Pesetas to Euros meant that many people in Italy and Spain weren’t millionaries any more, but it was merely a currency exchange. France’s change from “old francs” to “new francs”, same.
This is nonsense. Housing is an investment. It’s a capital purchase.
If you think Alan Greenspan, the Federal Reserve Board, Moody’s, S&P were all incredibly stupid, then I agree. But an average person has to rely on expertise to make financial decisions, and if the so-called experts are telling them that it’s a sound investment, it’s hardly foolish to follow their advice.
I’d be curious to see what you thought of S&P’s downgrade of the US government debt. If you think it was foolish to listen to S&P when it was rating housing, then you would agree that it’s foolish to listen to S&P when it’s rating government debt as well, correct?
Imagine you have taken your savings and made a loan to someone so they can buy a house (let’s say $300,000). They are paying you 4.5 % on a 30 year fixed mortgage. Five years down the road the house, which was worth $350,000 is now worth $225,000. The government tells you that the property has been revalued to $225,000 and the principal of the mortgage has been reduced accordingly. Oh and by the way, the interest rate has been reduced to 3%, because that’s where they are right now.
You have just taken a substantial loss. Would you ever make a loan like that again? From that point on, anyone wishing to buy a house would need to save up the full price of that house.
I am not a financial expert. I have, however, been involved in stock market investing for a long time. This is what I have noticed…
Never, never ever underestimate the impact of rich people losing money. Rich people losing money has huge , reverberating effects throughout the economy and can tank stock markets.
However, don’t overestimate normal people being hurt…it makes big news headlines but has little effect on the market.
So…Greece going to default? Who the hell would invest in Greek Bonds? Who would be that stupid? It can’t…just can’t be a big deal!? WRONG! This is rich people losing money…it can cause world wide recession and stock market crash.
A country get hit by natural disasters and thousands die? Bah…who cares.
My wife asked me the day Japan was hit hard earlier this year if I was going to get completely out of our investments. Why, I asked?. Japan is getting hit she said. Doesn’t matter I say. Sure enough, no effect on the stock market. For one day it did decline by a goodly amount but rapidily recovered…it was almost like it thought it should decline and so did for afew hours.
So, your proposal of reseting mortgages sounds like a good idea. However, it would cause rich people to lose money and so I would predict a stock market crash followed by a large deepening of the recession.
f a mortgage is $400,000, but the house behind it is only valued on the open market at $300,000 - then as long as the occupant has a job and can afford to pay the mortgage, and the bank does not have to sell their loan to another bank, the value might as well be $400,000. And who knows… maybe in 2 or 3 years the market will bounce back a little and it WILL be worth $400K. Then the owner (with a paid down mortgage) and the bank (with a reasonably valued asset backing the loan) are OK.
You are trying to have it both ways in this thread. If there’s wealth being handed out, then property values were valued correctly, and therefore people made sound investments during the boom, and we’re in some transitory, artificial slump. However, if property was overvalued during the boom, then there’s no wealth to be handed out. The only way you can believe wealth is being handed out is if you believe that property will recover to boom levels, and if you believe that, then people made completely rational decisions to purchase during the boom.
This is a general problem in this thread (and with a number of policy makers as well). We’re supposed to ignore the hit to the banks asset sheets that have already taken place, and the only way you can do that is if you think property values will recover. On the other hand, we’re supposed to punish people who invested in property, because they were stupid to think that property values would recover. It’s an incoherent position.