$$$ Lost & Found $$$

[Zygar]

OK, so it's just an "accounting" issue then, right, no real greenbacks involved?

I explained it about as clearly as it can be explained.

Let's try again. Let's pretend that you have $500K worth of oil. That oil suddenly drops in price because OPEC decided to flood the market. Now you have $300K worth of oil, even though you have the exact same oil.

Now lets say you were forced to sell it at $300K. You've now lost $200K.

The house is exactly the same thing as the oil.

Thanks for playing.

 

[Southwind17]

Nope.

Guess again.

I explained it about as clearly as it can be explained.

Let's try again. Let's pretend that you have $500K worth of oil. That oil suddenly drops in price because OPEC decided to flood the market. Now you have $300K worth of oil, even though you have the exact same oil.

Now lets say you were forced to sell it at $300K. You've now lost $200K.

The house is exactly the same thing as the oil.

Thanks for playing.

I understand all this, but I don't think you're extending your explanations to logical conclusions. Instead of drawing warm and cosy analogies that cause you to think it all makes sense, why not try explaining exactly why UBS has declared a $37.5 billion loss. They're in the business of lending money, aren't they?

p.s. Don't forget I had to buy the oil (house) in the first place. So $500 actually changed hands, and only $300 of it sits in mine now! And before you write it, yes, I know the seller of the oil (house) has the other $200, but the story doesn't quite end there now, does it.

 

[Zygar]

I understand all this, but I don't think you're extending your explanations to logical conclusions. Instead of drawing warm and cosy analogies that cause you to think it all makes sense, why not try explaining exactly why UBS has declared a $37.5 billion loss. They're in the business of lending money, aren't they?

p.s. Don't forget I had to buy the oil (house) in the first place. So $500 actually changed hands, and only $300 of it sits in mine now! And before you write it, yes, I know the seller of the oil (house) has the other $200, but the story doesn't quite end there now, does it.

Are you saying that no one ever built the house or mined the oil?

I'm not the one failing to reach the logical conclusion. You are thinking circularly.

 

[Modified]

I understand all this, but I don't think you're extending your explanations to logical conclusions. Instead of drawing warm and cosy analogies that cause you to think it all makes sense, why not try explaining exactly why UBS has declared a $37.5 billion loss. They're in the business of lending money, aren't they?

The loans were not entirely repaid, and never will be.

 

[Metullus]

How about this:

1. I have $500K.

Bob has a house worth $500K.

Together we have assets totaling $1million.

2. I buy Bob's house from him.

3. Now Bob has $500K.

Now I have a house worth $500K.

Together we have assets totaling $1million.

4. Market tanks.

5. Bob still has $500K.

Now I have a house worth $300K.

Together we have assets totaling $800K.

NOBODY HAS THE MISSING $200k.

 

[RandFan]

Let me add one little part of the equation.

Many of these sub prime lenders didn't actually originate all of the loans made. Many were originated by brokers who discounted the loans to these lenders. Their commissions constitute a small but still significant chunk of the money.

 

[shadron]

What's my theory? I don't have a theory, and nobody so far has offered a rational explanation. Unless I'm mistaken, when a financial institution "writes off" debt, which is the case with UBS, they're effectively agreeing to forego the return of funds invested - tangible funds, that is. So, where's the cash now? Remember, the loans were made largely against the security of the underlying assets. Those assets are now worth less than the value of the defaulted loans, largely driven by the lender's willingness to foreclose and cut its losses, presumably. So it seems to me that the original sellers of the assets are probably sitting on the money, which in essence amounts basically to a redistribution of wealth, from the UBS shareholders to the original property sellers, which could, in many cases, be the same people. Does this make sense?

Your theory is that the money is somewhere, hiding out. It isn't; it has simply disappeared. It is not mass/energy; it can be converted but it can also be destroyed and created. A steelworker creates it when he pours molten steel worth $500/ton into iron rail molds, the resulting rails worth $1000 per ton. He takes home $150.00 for his part. That's called adding value, and its what adds up to GNP - granted, with more complexity. A service person also creates wealth by selling something for more than it is actually worth, making it literally worth more. Likewise, wealth can disappear, as we have seen. It's not in anyone else's pocket, it's not paving the street. It has been destroyed. If it couldn't be created, then it would be whatever the world was worth when we "found" it, and it would never be worth more (or less, either).

Tangibility has nothing to do with it, because that wealth can, potentially, always be made tangible. Doing so often changes its value, but that's the way it is. If you cash in stock you have, then the value on the market declines, because more is available to be bought.

A very interesting thing about the market. Stock is issued to finance the company, and it realizes that income as the stock is sold (usually at the IPO). After it has been sold that once, it has no gain to be made from the value of the stock rising thereafter (unless it holds back some of it from sale, which often happens), but it is held liable by the stock holders to not allow the value to decline or even stagnate. It's not a mystery, but is just the way markets are. Think on that a while.

 

[Southwind17]

Ah, at last, Randfan's identified some, but not all, of it! The analogies still prevail, though. Please tell me which of the following steps I'm going wrong at, and why:

1. Bank lends me $500k to buy a house
2. I buy a house from Joe for $500k
3. Bank transfers $500k to Joe's account
4. I fail to keep up the loan payments
5. Bank forecloses
6. Bank sells house to Bill for $300k
7. Bill transfers $300k to Bank's account
8. Bank has lost $200k
9. We don't know what Joe has done with the $200k, but it physically exists somewhere in the economy
10. Extend this, and at least $37.5 billion now physically exists somewhere in the economy that the UBS Board did not expect to 12 months ago

 

[Zygar]

Ah, at last, Randfan's identified some, but not all, of it! The analogies still prevail, though. Please tell me which of the following steps I'm going wrong at, and why:

1. Bank lends me $500k to buy a house
2. I buy a house from Joe for $500k
3. Bank transfers $500k to Joe's account
4. I fail to keep up the loan payments
5. Bank forecloses
6. Bank sells house to Bill for $300k
7. Bill transfers $300k to Bank's account
8. Bank has lost $200k
9. We don't know what Joe has done with the $200k, but it physically exists somewhere in the economy
10. Extend this, and at least $37.5 billion now physically exists somewhere in the economy that the UBS Board did not expect to 12 months ago

No.

You are missing the fact that $200K of real equity was lost. Please start over with someone buying the property, someone building the house, economic inflation that raised the equitable value of the house to $500K...

In other words, you are looking at the whole thing very simplistically. Economy is based upon resources, not cash. The loss of value of a resource is far more detrimental than the loss of some cash.

 

[jimtron]

Southwind, do you understand that the value of things (houses, cars, stocks, etc) can fluctuate a great deal? The economy isn't just about currency moving from one place to another. There are antique postage stamps that cost a penny or two originally, but because they are very very rare, they are worth thousands of dollars. The value of things is very fluid.

Enron stock plummeted. Where did that money go? Thin air. The value of the stocks went from expensive to worthless when it was discovered that the business was a house of cards.

 

[Southwind17]

So which step(s), 1 through 10, does not hold true, and why?

 

[jimtron]

So which step(s), 1 through 10, does not hold true, and why?

They're all true. Values of real estate have gone down. Banks loaned money too easily. Do you understand that values of property can fluctuate wildly?

eta: When bank make loans, there's a risk involved. If you loan me $100, you may or may not ever see the money again. The banks made a lot of loans, sometimes to folks with less than stellar credit. When they don't get paid back, they lose money.

 

[Southwind17]

They're all true. Values of real estate have gone down. Banks loaned money too easily. Do you understand that values of property can fluctuate wildly?

eta: When bank make loans, there's a risk involved. If you loan me $100, you may or may not ever see the money again. The banks made a lot of loans, sometimes to folks with less than stellar credit. When they don't get paid back, they lose money.

My line of questioning might suggest that I know next to nothing about finance and the fluctuating value of assets. That's not true. I've built, bought and sold many properties, luckily(?!) never at a loss. What I don't understand, and I'm not afraid to admit it, clearly, is what, exactly, commentators mean by "loss" in the context of write-downs against property loans. Clearly, the banks have loaned money to Joe public - hard cash, that is. They've foreclosed, or assumed foreclosure, and only expect to recover a proportion of what they've loaned - again hard cash. The balance - yet again hard cash - doesn't simply disappear, even if asset values have fallen, which they clearly have. The cash exists somewhere. I'm not suggesting it's under somebody's pillow, so to speak, but it must be in the economy, and given that the banks didn't expect to lose the money when they loaned it (or they wouldn't have loaned it), then similarly whoever holds the money now didn't expect to be holding it. So somebody must have unexpectedly gained from it.

 

[Jaggy Bunnet]

I'm not suggesting it's under somebody's pillow, so to speak, but it must be in the economy, and given that the banks didn't expect to lose the money when they loaned it (or they wouldn't have loaned it), then similarly whoever holds the money now didn't expect to be holding it. So somebody must have unexpectedly gained from it.

Nope, this is totally illogical.

Taking your ten steps, who do YOU think has "unexpectedly gained"?

It's not Joe, because he had a house worth $500 which he sold for $500k. No unexpected gain.

It's not Bob, he still owes the bank $200k but is not going to be able to repay it. If you want to make the numbers add up, then Bob goes bankrupt and "unexpectedly gains" $200k because he gets rid of his debt to the bank without paying anything for it (because he has no assets to do so).

It's not the bank. They put $500k of cash out and got $300k back. No unexpected gain there.

So, who do you think it is? And if you can't point to anyone who you think it is, does that not cause you to examine your theory that this person must exist?

 

[Modified]

My line of questioning might suggest that I know next to nothing about finance and the fluctuating value of assets. That's not true. I've built, bought and sold many properties, luckily(?!) never at a loss. What I don't understand, and I'm not afraid to admit it, clearly, is what, exactly, commentators mean by "loss" in the context of write-downs against property loans. Clearly, the banks have loaned money to Joe public - hard cash, that is. They've foreclosed, or assumed foreclosure, and only expect to recover a proportion of what they've loaned - again hard cash. The balance - yet again hard cash - doesn't simply disappear, even if asset values have fallen, which they clearly have. The cash exists somewhere. I'm not suggesting it's under somebody's pillow, so to speak, but it must be in the economy, and given that the banks didn't expect to lose the money when they loaned it (or they wouldn't have loaned it), then similarly whoever holds the money now didn't expect to be holding it. So somebody must have unexpectedly gained from it.

Of course, someone or many people now have the cash that was not repaid on the loan. The amount of cash has not changed. When people say there is a net loss, they are considering houses to be monetary assets. The total value of cash + house values has decreased.

 

[Modified]

It's not Bob, he still owes the bank $200k but is not going to be able to repay it. If you want to make the numbers add up, then Bob goes bankrupt and "unexpectedly gains" $200k because he gets rid of his debt to the bank without paying anything for it (because he has no assets to do so).

From a purely cash perspective, that is the answer. The people who owe money they will never repay are the winners.

 

[meg]

Here's how I understand the problem, which is not just that the value of the house tanked, but that the value of the mortgage tanked.


Bob bought a house for $500k from Joe, so he took out a $500k loan from Bank-A.

Bank-A offered to loan Bob $500k, at a variable interest rate, which at the time was 3%. Bank-A charged Bob a fee of 3 pts to get this great loan, which came to $15,000. Bank-A understood that over the 30 years of loan repayment, Bob would pay $258,857 in interest* if he stuck with his agreed upon monthly payment of $2108.02.

Bank-A then sells the mortgage to Bank-B. Which means Bank-B pays Bank-A $500,000 + some small percentage of the loan, lets say 3%, which comes to another $15,000.

So here's the tally so far:

Joe has $500k so he can go buy another house or something.
Bob has a house worth $500k.
Bank-A has $30,000 they didn't have last week (3% paid by Bob + 3% paid by Bank-B) minus a small amount for what it actually cost them in time and energy to type up all the papers.

Bank-B has a piece of paper they paid $515000 for, which will earn them $758,857, at present interest rates, and even more when interest rates go up. The bought the paper betting that interest rates would go up, and they were right.

Interest rates go up to 6%.
Bank-B is happy because now the piece of paper they paid $515000 for is worth $1,079,190 ($500k + 6% interest for 30 yrs)**. Bank-B is so happy they turn around and sell the mortgage to Bank-C for 6pts, which comes out to $545,900 ($515,000 + $30,900)

Bob is not happy. His payment is now $2997.75 a jump of over $800/month. It's a stretch, but he can squeak by.

Bank-C now has a piece of paper they paid $545,900 which will make them $1,079,190 at present interest rates. They are betting that interest rates will rise, and they'll make even more money.

Interest rates go up to 8%.

Bank-C is happy because now the piece of paper they paid $545,900 is worth $1,320,776.

Bob is in trouble and seriously UNhappy, because now his house payment is $3668.82 and he can't afford it anymore.

Bob wants to refinance, and try to get his payment back under 3k/month, but he can't, because the boom is over, and nobody is willing to pay $500k for a house like his anymore. The market has "corrected" itself. At most, they say, his house is now worth $300k. Nobody in the free world is willing to lend him $500k for a $300k house.

He tells Bank-C "either you get my payment under $3000/month, or you will have to foreclose.

Bank-C is now unhappy, too. The piece of paper they paid $545,900 is now pretty much worthless.

They only have a few choices. They can either

1. Foreclose, and try to sell the house themselves, which maybe will get them $250k at auction, at which point they calculate $545,900 (original cost) - $250,000 (recouped price) = a loss of $295,900. If Bank-C has 100 mortgages like this, they lose $29,5 million and 100 Bobs and Bobettes have lost their homes and ruined their credit for years.

or

2. They can refinance the $500k loan to Bob at 6% even though loans are going for 8% now. That means the value of their piece of paper that used to be worth $1,320,776 is back to only being worth $1,079,190, which means they have to "write off" a loss of $241,586.

The problem with that is that banks aren't supposed to loan out a bunch of money on mortgages without having some "real" value to back it up. So to really calculate out what the value of the mortgage is, you have to take into account the now reduced value of the house.

A new realistic loan on that same house would be $300k (the current value) at 8% (the current interest rate), which means the loan is "really" worth $300k + $492,465 in interest, which comes to $792,465. The piece of paper which last week was worth $1,320,776 is now worth $792,465, which comes out to a loss of $528,311.

If Bank-C has 100 loans like this, last week their assets were worth $132,077,600. This week their assets are worth $79,246,500. This bank just "lost" $50 million, and 100 Bobs and Bobettes are stuck with a $500k mortgage on a $300k house, so they can't sell or move (without going bankrupt) until the value of their house goes back up to around 500k, which could take decades.



* Numbers taken from a mortgage calculator found here: http://www.bankrate.com/brm/mortgage-calculator.asp

**The way they calculate what a mortgage is really "worth" is far more complicated than this in real life.

 

[Zygar]

So which step(s), 1 through 10, does not hold true, and why?

They are all true. But you need to add a significant number of steps before your "step 1".

 

[jimtron]

They've foreclosed, or assumed foreclosure, and only expect to recover a proportion of what they've loaned - again hard cash. The balance - yet again hard cash - doesn't simply disappear, even if asset values have fallen, which they clearly have. The cash exists somewhere.

What do you mean exactly by "hard cash"? Much of what we're talking about does not involve hard cash. A lot of this is based on trust and faith. Usually when you buy property, as you know, you only pony up the down payment. So you own it, but you've only provided a small percentage of the value in cash. And if the property appreciates or depreciates while you own it, that change in value doesn't manifest itself in "hard cash." It's more abstract (for lack of a better term).

 

[Southwind17]

What do you mean exactly by "hard cash"? Much of what we're talking about does not involve hard cash. A lot of this is based on trust and faith. Usually when you buy property, as you know, you only pony up the down payment. So you own it, but you've only provided a small percentage of the value in cash. And if the property appreciates or depreciates while you own it, that change in value doesn't manifest itself in "hard cash." It's more abstract (for lack of a better term).

By "hard cash" I mean that cash, effectively, actually changes hands, although as the home buyer you probably won't actually see it. If I sold my home now without buying another I'd see my bank balance increase by the sale price (less expenses). I could, if I wanted, draw that cash and buy a car with it, for example. So, from UBS's persepective, when they loan money it's real money we're talking about, not just a theoretical economical accounting exercise regarding equity values. What do you think UBS mean when, as a money lender, they say they've lost $37.5 billion?