crisis over?

[Gagglegnash]

Hi

<pedantry alert>

Surely that VI means six, not five? Five is V.

</pedantry alert>

D'oh!! (_8(|)

That 'I' wasn't there just a second ago!!

D'oh!! D'oh!! D'oh!! D'oh!! D'oh!! D'oh!! D'oh!! (_8(|)

When I would do it while teaching computer programming (FORTRAN, COBOL, Pascal, C and... ummm... well... BASIC),
I'd write '5', and ask what it was,
wait for an answer, 'huh - dunno'
I'd say that's a five, then write 'V' and ask, well, then what is this,
wait for an answer, 'oh - a five'
then write 五 오 四 and ask then, what are those.
wait for the inevitable answer, 'five, five and five,'
then I'd say, yeah, well, that last one is a FOUR, but you get the idea.

It's all about physical stuff representing conceptual stuff - in this case, the idea of numerals instead of numbers.

My subconscious may have been rebelling at passing up the opportunity for a perfectly good joke....

 

[Gurdur]

You hate us pedants, yes?

 

[Gagglegnash]

Hi

You hate us pedants, yes?

Can't. Used to be one!

 

[Gurdur]

Hi
Can't. Used to be one!

No worries, you should see what I myself get wrong! I typo all the time, and I have no idea at all of grasping the personal past, so I get number of years ago often wrong too.

 

[Ethan Thane Athen]

...
Yes, on average, "only" 10% of all mortgages are in default (meaning behind at least 30 days per MBA calculation methods [I think], not in foreclosure/bankruptcy as you stated). But that 10% is killing your cash flow. You are expecting to get paid every month and the money just stops while your costs go up. ...
CT

Are you really saying that banks that have been making millions (billions?) of dollars profit for years, have a business plan that can't cope with a 10% drop in cash flow? After all, from the first part of your quote, the money hasn't 'just stopped' as the second part suggests, they're still getting 90% of it and will get something back from the sale of the re-possessed house, even if it's not their full amount. With all the profit they've made, they should have some spare to tide them over the crisis surely?

I obviously don't understand economics either as this just seems like complete mismanagement to me.

Oh and as for government interference pushing the sale of mortgages to those who can't afford them, I'd be astonished if the position in the States was that different to the UK where the main (by far) reason for giving mortgages out in such circumstances is the greed of the salesman for his commission, a naive assumption that house prices will continue to rise (they do long term but they always have periods of plateau / slight drop and that's been predicted in the UK at least 3 years back - along with large numbers of exposes of mortgage lenders encouraging buyers to lie about their salaries) and the complete disregard for the consequences.

Furthermore, all the elements of the current problem were predicted several years back but the banks etc just kept doing their thing - probably because the individuals concerned just wanted to make as much money as they could before the bubble burst.

Firms should go to the wall over this - that's what the market economy means. The huge sums of money talked about in the bailout could perhaps be used to soften the blow to the 'ordinary' person affected rather than to rescue companies whose excuse when they took obscene salaries and bonuses was 'Ah that's the market, high risk equals high reward.' Yup or high losses when you get it wrong. 'The value of your investment may go down as well as up' - that's called gambling buddy, and you lost.

NB The above is a self-admittedly naive and emotional rant and I won't pretend to defend it against those more expert in the subject than myself but I expect it accurately matches what a majority of the population think.

 

[Miss_Kitt]

Must agree with several comments above.

We are facing a liquidity crisis. BUT I don't think we need to give $700 BILLION to cover that crisis. The US Government doesn't want anyone to lose their job, their business, or their house right before a presidential election, so they're going to mortgage us, our kids, and our grandkids so that "no one gets hurt".

I have news: Lots of the players should get hurt. Part of the problem here is that quasi-government entities Freddie Mac and Fannie Mae were playing the mortgage game, and implicitly everyone believed that they were "too big to go bust" as well as having an "in" to the Federal Government's deep pockets. Which, sadly, it turns out they did.

The only thing the feds should do is support liquidity, basically by offering to fund interbank loans for the short term at low rates. (Of course, those funds need to come with some controls to verify that they get used to fund loans to other banks instead of paying golden parachutes and going out as dividends.) The risk here is that in their eagerness to do Something Right Away, the Congress will do something stupid and lobbyist-driven involving giving tons of taxpayer cash to large banks and other financial entities in exchange for, well, their promise that they'll be smarter this time.

Banks and investment funds have been buying and selling grossly overvalued mortgages for some time, and they should take a big hit. Banks that are too exposed should fail, frankly, and the FDIC should do its job and pay the depositors their cash. What is going to be tough is convincing the average American that it's not the end of the world if a bank fails. Any business can fail, and if they buy things for more than they are worth, they are going to fail.

The only regulatory fix I can see might--I say might because I haven't had much time to think about this--has to do with transparency of mortgage-backed securities and/or requiring a certain percentage of originated loans REMAIN with the first lender. Buffett's mortgage company is doing very well, thank you, even with their sub-prime borrowers--because they evaluated the loans on the basis of keeping them. In contrast, many other banks (and virtually all mortgage brokers) were looking at the loan fees as the source of income, and the loan itself as just a commodity to buy and then resell.

Washington Mutual was taken over by the feds and resold instantly; and while Seattle has lost a good corporate citizen, neither the taxpayers nor the account holders have been harmed. WaMu played fast and loose with its mortgage business, and it paid the ultimate price. Sad for the people whose retirement was supposed to be financed by the $35 shares of stock that are now worth pennies...but stuff happens.

I am frankly sick and damned tired of the competent, smart, capable, and fiscally prudent having to pay for the feckless, stupid, and profligate--plus the government's handling fee of about $6 per dollar distributed. And I am unable to deeply care if the US's financial troubles are rebounding on the world: It defies logic that the governments in Europe and Asia are condemning the US Congress for not leaping on a bad piece of legislation so that investor confidence overseas is unshaken. The US taxpayer owes NOTHING to the shareholders of the Nikkei, nor should we expect the government of Japan to change its fiscal policies to support the NYSE.

It's too late to be arguing politics and economics, hopefully this post won't be too embarassing when I reread it tomorrow, Miss Kitt

 

[Ethan Thane Athen]

It's too late to be arguing politics and economics, hopefully this post won't be too embarassing when I reread it tomorrow, Miss Kitt

Makes a lot of sense to me...though as I noted above, that's necessarily a strong recommendation. For what it's worth though, I thought that was a superb post.

 

[Magyar]

Gaggle,

Thank you for your patience and thorough explanation. It's beginning to make sense in the large picture, but I am still with Ethan on this (post 25).

Are we saying that these multi-Billion institutions were/are operated so poorly or so tight a margin that they could not survive a drop of >10%? ( I think that actual foreclosures, your dirt and drywall is more like 3%)

I find that incredible!? aren't there rules about having to keep a certain percentage of cash on hand, or did that not apply to these institutions because of the dereg?

Also, my understanding is that the vast majority of foreclosures and/or defaults are due to the ARM going up faster/higher. Thus the owner/tenant can no longer make the payment. They still have their jobs etc so if the payment wasn't going up due to the ARM they would continue to stay. ( Yea I know the stink factor in this) In this situation wouldn't it make more sense for these institutions to re-write the paper to a fixed rate that is lower then the current ARM but higher then the starting one and lose some future profit on interest but retain the cash flow.

While I know that there are some people who just don't give a sh8 and want to walk away, or due to some issues simply can not make any payment (we always have those) my guess is that the vast majority of people in foreclosure WANT to keep their homes.

 

[Magyar]

blackadder,


Since no one answered. yes you can buy some fairly nice houses in the US for @$100,000 depending on where you are. In the midwest and southern states especially.

I was forced to live in OH for a few years (family stuff) and built a brand new house with an acre of land 2 car garage and about 2000 sq ft living space for $98K in the mid 90's.

BUT, 5 years later we moved to the Boston area and I paid considerably more for JUST the land of the current house we live in and that was in a down market before the R/E bubble.

 

[CriticalThanking]

Are you really saying that banks that have been making millions (billions?) of dollars profit for years, have a business plan that can't cope with a 10% drop in cash flow? After all, from the first part of your quote, the money hasn't 'just stopped' as the second part suggests, they're still getting 90% of it and will get something back from the sale of the re-possessed house, even if it's not their full amount. With all the profit they've made, they should have some spare to tide them over the crisis surely?

I obviously don't understand economics either as this just seems like complete mismanagement to me.

10% is the average, and continues to climb. But that is only one component of your cash flow. If you are no longer originating new loans, you are not getting the up front fees, interest spread, etc. Foreclosures and related costs continue to climb. Legal costs for defending yourself against shareholder, investor, and state attorney general lawsuits are skyrocketing. The company costs are going up at the same time your cash flow drops. How long should a company be able to survive such a trend? A year? 2 years? This has been going on for a while and has not peaked yet.

[snip]
NB The above is a self-admittedly naive and emotional rant and I won't pretend to defend it against those more expert in the subject than myself but I expect it accurately matches what a majority of the population think.

Many in the industry feel the same way about punishing those who made the bad loans. Many of the executives are gone (with bonuses/payouts that would be another rant by itself). Now what? Lay off 20-40% of the staff that had nothing to do with sales?

CT

 

[CriticalThanking]

[snip]
Also, my understanding is that the vast majority of foreclosures and/or defaults are due to the ARM going up faster/higher. Thus the owner/tenant can no longer make the payment. They still have their jobs etc so if the payment wasn't going up due to the ARM they would continue to stay. ( Yea I know the stink factor in this) In this situation wouldn't it make more sense for these institutions to re-write the paper to a fixed rate that is lower then the current ARM but higher then the starting one and lose some future profit on interest but retain the cash flow.

While I know that there are some people who just don't give a sh8 and want to walk away, or due to some issues simply can not make any payment (we always have those) my guess is that the vast majority of people in foreclosure WANT to keep their homes.

I can't speak for all mortgage firms, but the analysis I have seen is that well over 90% of ARM borrowers in default went into default because of "curtailment of income" before the ARM rates began to rise. Several months' worth of delinquency due to job loss, even short term job loss, is difficult to make up. How many people keep 6 months expenses in cash for just such an emergency?

And yes, many lenders are working with borrowers to modify loans. They are getting rather creative: drop interest rates, convert to fixed rate, "forgive" some amount of principal balance and fees, accept the delinquent amount over time without incurring penalties, take a second note (possibly through a third party), extend the term, refinance completely, etc...Think about what a large firm goes through. If 10% of your 1 million customers are in default, that means you are working directly with 100,000 customers every month. You have to speak with them, verify financials, execute legal documents for loan modifications, etc. Now scale that up to the large firms with multiple millions of loans. It is a big part of operations dedicated to the people who are impacting your cash flow.

CT

 

[drkitten]

Are we saying that these multi-Billion institutions were/are operated so poorly or so tight a margin that they could not survive a drop of >10%? ( I think that actual foreclosures, your dirt and drywall is more like 3%)

I'm trying hard to think of any mature industries that typically have operating margins in excess of 10%. I'm failing, I'm afraid.

I find that incredible!? aren't there rules about having to keep a certain percentage of cash on hand, or did that not apply to these institutions because of the dereg?

Don't confuse cash-on-hand with cash flow. Cash on hand merely means that I can keep the doors open longer once I start losing money because the money in no longer matches the money out.

 

[dudalb]

NB The above is a self-admittedly naive and emotional rant and I won't pretend to defend it against those more expert in the subject than myself but I expect it accurately matches what a majority of the population think.

Boy, that last statement will really go over well here.
As General Sherman said "Vox Popoli, Vox Humbug".

 

[Magyar]

OK, obviously my knowledge of economics is very limited, but apparently FAR FAR better then most of these guys running multi billion dollar companies. My business operates at a far higher margin than 10% and has for the past 12 years. I also have at least 6 months worth of operating expenses (actually it has never gone below 6 months, most of the times it's more than that) on hand in cash in case something bad happens. But I also don't pay myself or my employees stupid money when they don't make me a profit. Goofy me.


So after all this is said and done -

1) How did they come up with this 700B figure - when everyone keeps talking about how they don't know the value of the assets or how far it goes etc etc.

2) how will this bail out help solve the problem, or will it just put off the inevitable at more expense?

 

[drkitten]

OK, obviously my knowledge of economics is very limited, but apparently FAR FAR better then most of these guys running multi billion dollar companies. My business operates at a far higher margin than 10% and has for the past 12 years.

Translation : My business has an ROI almost indistinguishable from a mattress.

I also have at least 6 months worth of operating expenses (actually it has never gone below 6 months, most of the times it's more than that) on hand in cash in case something bad happens.

... especially if you can afford to lock half your yearly expenses away in a cash investment.

2) how will this bail out help solve the problem, or will it just put off the inevitable at more expense?

"Putting off the inevitable" until it becomes evitable is often a good strategy for dealing with problems involving stochastic processes. If a casino has a big winner, for example, (more than they can pay), it's often in their best interest to keep the guy at the table until the law of averages brings his winnings more in-line with rational expectations. If you have a good farm but a bad harvest, the best thing to do is probably to wait until next year.

Most businesses operate with semi-stochatistic earnings; if you think about, for example, a used car lot, the owner may sell 1200 cars a year, but he's NOT going to be selling 100 cars a month or 3-4 cars a day. Some months will be good, some will be bad, and he relies on a line of credit from the bank to keep the doors open during bad months. Under normal circumstances, he can buy such a line of credit much more cheaply than the opportunity cost from keeping six months expenses in a cash account. (I believe the industry term for this is the "floorboard"), especially since he rarely needs to tap it, so the actual cost for most months is barely above the fees.

Unfortunately, the banks are no longer willing to give him enough credit. (That's what a "credit crunch" means.) This means that if he has a bad month, he can't make payroll and has to close his doors.

Most main street businesses have this kind of stochastic earnings. Most retailers, for example, barely break even (or even lose a bit) during much of the year, and then make money in gobs during the holiday season. Heck, grocery stores have this kind of cash flow, and you wouldn't think that people eat that much less in July than they do in December, until you remember all the fruitcakes that get make, gifted, and thrown away. Except now, this October, the little corner grocery store has just been told that the bank won't front them the money for fruit cake mix, and so it won't be able to make payroll this November.

And it's not that the grocery store and the used car lot aren't fundamentally sound businesses. But part of their business plan involves using (low cost) credit lines as leverage to boost the ROI, and without cheap credit, they can't run the business. If we could find an alternate source of cheap credit, they could stay in business and even prosper.

So the government has two obvious choices. One is to set up a "national" bank to offer cheap credit for the people who are good for it but who can't get a loan because of the credit crunch, and the second is to prop up the banks so they don't have to pull all of their capital out of circulation to cover the failed mortgage loans.

 

[Magyar]

Translation : My business has an ROI almost indistinguishable from a mattress.
... especially if you can afford to lock half your yearly expenses away in a cash investment.

wow - could you translate that 'cause I don't even know if I am supposed to be insulted or what!?

"Putting off the inevitable" until it becomes evitable is often a good strategy for dealing with problems involving stochastic processes. If a casino has a big winner, for example, (more than they can pay), it's often in their best interest to keep the guy at the table until the law of averages brings his winnings more in-line with rational expectations. If you have a good farm but a bad harvest, the best thing to do is probably to wait until next year.

Most businesses operate with semi-stochatistic earnings; if you think about, for example, a used car lot, the owner may sell 1200 cars a year, but he's NOT going to be selling 100 cars a month or 3-4 cars a day. Some months will be good, some will be bad, and he relies on a line of credit from the bank to keep the doors open during bad months. Under normal circumstances, he can buy such a line of credit much more cheaply than the opportunity cost from keeping six months expenses in a cash account. (I believe the industry term for this is the "floorboard"), especially since he rarely needs to tap it, so the actual cost for most months is barely above the fees.

Unfortunately, the banks are no longer willing to give him enough credit. (That's what a "credit crunch" means.) This means that if he has a bad month, he can't make payroll and has to close his doors.

Most main street businesses have this kind of stochastic earnings. Most retailers, for example, barely break even (or even lose a bit) during much of the year, and then make money in gobs during the holiday season. Heck, grocery stores have this kind of cash flow, and you wouldn't think that people eat that much less in July than they do in December, until you remember all the fruitcakes that get make, gifted, and thrown away. Except now, this October, the little corner grocery store has just been told that the bank won't front them the money for fruit cake mix, and so it won't be able to make payroll this November.

And it's not that the grocery store and the used car lot aren't fundamentally sound businesses. But part of their business plan involves using (low cost) credit lines as leverage to boost the ROI, and without cheap credit, they can't run the business. If we could find an alternate source of cheap credit, they could stay in business and even prosper.

So the government has two obvious choices. One is to set up a "national" bank to offer cheap credit for the people who are good for it but who can't get a loan because of the credit crunch, and the second is to prop up the banks so they don't have to pull all of their capital out of circulation to cover the failed mortgage loans.

well, then I would say that they are operating their business on a far higher risk tolerance than I am comfortable with. I didn't realize that people run their business on such a mrginal level - that's really kind of sad. Maybe that is a reason why I won't need to go to a bank to beg for money to survive. Also means if my competitors operate like your fruitcake maker, I'll be rolling in it once we hit the uptick, or even before since I can take over their maintenance contracts and repairs since they won't be around.

Thanks for making my day

 

[drkitten]

wow - could you translate that 'cause I don't even know if I am supposed to be insulted or what!?

ROI is "return on investment"; basically, how much money you make for every dollar invested in the business.

And, yes, it's related to risk tolerance

well, then I would say that they are operating their business on a far higher risk tolerance than I am comfortable with.

Quite possibly. That's not, however, a good thing. It means that you're wasting a lot of profit-making opportunities.

Also means if my competitors operate like your fruitcake maker, I'll be rolling in it once we hit the uptick,

Actually, it means exactly the opposite; when the uptake happens, they'll be returning something like 10x the profits you are, precisely because they're fully-invested in the business instead of running it like a hobby.

Especially if you're the sort of hobbyist that doesn't even track your ROI.

 

[roger]

magyar, I don't know what your business is, but suppose you made auto parts, and your margin is 20%. That's a very attractive margin, and a competitor is sure to start underselling you, at maybe a margin of 18-19%. You have no choice but to compete, bringing your margin down to 17%. well, meanwhile another competitor sees what the two of you are doing, and wants a slice of that pie. Here comes the 16% margin, and you lose more business.

Before you know it, the water is full of sharks, blood is flowing, and everyone is running at the edge of what risk and prudence allows - around the rate drkitten mentioned.

If you manage otherwise, I suspect you have a tiny business, or have a durable competitive advantage, which is hard to come by. It's certainly not the norm; how could it be the norm to be above average? So, count your blessings, but don't slag off the people running multi-billion businesses facing competitive pressures you aren't. It's the nature of competition and the opportunity cost of money - if you don't do it, your competitor will, grabbing your market share in the process. Truly great businesses with a durable competitive advantage do tend to have quite a bit of cash on hand, but that is pretty rare for the reasons stated above.

ETA: as for the mattress comment, probably I should let drkitten answer for himself, but it's standard business practice to look at how to invest your money. Say you do have a durable competitive advantage, and have a 20% margin. If you can borrow at 500+LIBOR, it is very smart to invest that money into your business, and then borrow as necessary to manage cash flow. Again, this assumes a larger business, and a good revolving credit facility. If I ran a mom and pop grocery I'd look to have quite a bit saved up too, more along your model, but recognize that my finances in no way reflect how a large cap public company should manage its assets.

 

[Francesca R]

Oh and as for government interference pushing the sale of mortgages to those who can't afford them, I'd be astonished if the position in the States was that different to the UK where the main (by far) reason for giving mortgages out in such circumstances is the greed of the salesman for his commission, a naive assumption that house prices will continue to rise (they do long term but they always have periods of plateau / slight drop and that's been predicted in the UK at least 3 years back - along with large numbers of exposes of mortgage lenders encouraging buyers to lie about their salaries) and the complete disregard for the consequences.

It is not "complete disregard for the consequences"--it is incorrect assessment of the possible consequences, and the observation that if everybody gets it a bit wrong in the same direction, then the positive correlation of this error actually changes how wrong they got it from "a bit" to "a whole lot". You might estimate how long it takes you to drive from A to B--say 1 hour--and perhaps you underestimate it by 10 minutes . . . now if for some reason you have to get from A to B, and you start to fear you have underestimated it a bit and you are going to be slightly late and so does everyone else in town you will find that your underestimate gets magnified from 10 minutes to several hours because you did not realise that everyone else made the same error that you did and they are all trying to correct for it at the same time. That's not a brilliant analogy but it shows how correlated mistakes magnify their consequences well beyond the initial error. And it it easy to be wise after the event. But the preventative solution would not be to habitually overestimate an hour's journey time by several hours because of the amount of time you'd routinely waste being way too early to arrive everywhere.

BTW self-certified mortgages were not created so that people could lie about their earnings, regardless of whether they provide the means to do this. I have a friend who is self employed and, at the advice of his accountant, pays himself a paltry salary from his company and a typically large share dividend. If he stated his salary to a lender he would not get a mortgage, hence he volunteers his income via self-certification.

Firms should go to the wall over this - that's what the market economy means. The huge sums of money talked about in the bailout could perhaps be used to soften the blow to the 'ordinary' person affected rather than to rescue companies whose excuse when they took obscene salaries and bonuses was 'Ah that's the market, high risk equals high reward.' Yup or high losses when you get it wrong. 'The value of your investment may go down as well as up' - that's called gambling buddy, and you lost.

Why don't you extend this "all's fair in up and down markets" more widely then? If Slow Joe Crow's Country Store goes belly-up because he failed to allow for the possibility that a crisis in interbank lending might push his monthly borrowing rate up to Fed-funds-rate + 30% for a few months, then surely that's Slow Joe Crow's lousy risk management? Where do you draw the line between "ordinary person deserving protection" and "person who screwed up"?

Almost every economic agent in the system uses the "bell-curve" to a greater or lesser extent, and Benoit Mandelbrot's power laws and Nassim Taleb's pointing out of black swans do not and can not always help them. If every business behaved like an Antarctic survivalist, there would be an order of magnitude less business being done, which would in turn require even more self-protection from extreme adverse consequences (because those consequences would hit fewer people harder), and there would have to be an iterative recalibration of just how much you should hunker down and stockpile cash until nobody dared open a store unless they had--I dunno--six years of working capital cashflow stashed in the back (probably with a load of weapons).

NB The above is a self-admittedly naive and emotional rant and I won't pretend to defend it against those more expert in the subject than myself but I expect it accurately matches what a majority of the population think.

Yes it probably does, I would agree with that. A lot of people think that "the bailout" is targeting entirely the wrong people and/or is not needed. The latter view is probably because--aside from mortgage delinquencies and house reposessions--not a great deal of economic pain has been felt on main street. Actually that is why fiscal expansions (other than tax cuts which most people like at any time) are very hard to get done "early", and why eventual government responses to economic accidents often get viewed as "too little, too late".

 

[Francesca R]

OK, obviously my knowledge of economics is very limited, but apparently FAR FAR better then most of these guys running multi billion dollar companies. My business operates at a far higher margin than 10% and has for the past 12 years. I also have at least 6 months worth of operating expenses (actually it has never gone below 6 months, most of the times it's more than that) on hand in cash in case something bad happens. But I also don't pay myself or my employees stupid money when they don't make me a profit. Goofy me.

Then you approximately match the description of "survivalist" that I just alluded to, which renders you quite well "armed" to ride out today's event. But:

1--Not everyone runs their business this way and everyone cannot run their business this way without reducing the return on capital for the system as a whole, which would squeeze down economy-wide profits and reduce the number of profitable players and downsize national income. This could be explained more step-by-step and more rigorously, which I have not done, but it is a deterministic result.

2--You are more vulnerable to be outcompeted by firms operating at a higher degree of leverage in most other scenarios; your (low) leverage would bring you peace of mind but would be out of line with the more optimal amount of it that others were comfortable with. This is what drkitten and roger have discussed. If that has not happened to you, congratulations and continued best wishes for success