Comments on: Continuing risks in the housing market

By: Andrewp111

Andrewp111 — Fri, 04 Jun 2010 09:11:13 +0000

It is only a nonrecourse loan in about 11 states, but one of those is a true biggie – California. In the DC area, it is otherwise. Residental mortgages in Virginia are definately full recourse. Furthermore, the lender has additional leverage here from the fact that >80% of the people in the capitol area work for the US government or its contractors. Getting a deficiency judgement can cost you your security clearance, and thus your job.

By: Sensei

Sensei — Fri, 04 Jun 2010 05:35:37 +0000

Speaking of CR, here’s the incomparable Tanta on Options Theory and Mortgage Pricing, from 2008:

http://www.calculatedriskblog.com/2008/0 1/options-theory-and-mortgage-pricing.ht ml

By: Uncle_Billy

Uncle_Billy — Fri, 04 Jun 2010 03:48:50 +0000

“And it’s equally obvious that no one has even attempted to quantify the numbers involved here — just how much has the value of banks’ performing mortgages fallen? And how does that number compare to the banks’ own equity?”

Ask CR. I think he’s done this sort of accounting in the past.

By: guruintraining

guruintraining — Fri, 04 Jun 2010 02:58:27 +0000

I agree, its a call option. You have the option of purchasing the home from the lender for the outstanding balance on your mortgage.

By: david3

david3 — Fri, 04 Jun 2010 01:50:22 +0000

Classic Minsky framework. Hedge Unit ->> Speculative Unit ->> Ponzi Unit.

Actually a borrower, on say a 2/28 subprime adjustable-rate mortgage with no money down, was getting a free at the money call option. As prices went up the option became in the money, but if not the borrower could default and lose what was the free option they had effectively started with.

By: NLord

NLord — Thu, 03 Jun 2010 19:55:25 +0000

just to let you know, Felix, I teach at a fairly large state university and am looking at an excel doc entitled “2010 Salary Roster.” Of the 2000 employees, would you care to guess how many are tenured professors earning $200K or more?

Two.

You can get the number up to ten if you count Deans and the like.

I’m pointing this out only because nobody ever uses the example of, say, “a tenured professor earning 80K”–and believe me, that conjures up a far more typical image of salaries in the American college and university system.

By: Sandrew

Sandrew — Thu, 03 Jun 2010 19:01:54 +0000

“I would be much more reassured if there were some numbers marking banks’ mortgage books to some kind of market or model.”

To the extent banks’ mortgage books are held in the form securities (i.e. MBS, as opposed to whole loans)–and I thought this was most of it, no?–I believe the rule is that they be held in three accounting buckets: trading, available for sale, and held to maturity. The first two buckets should be marked-to-market on the balance sheet, with periodic changes flowing through P&L and “other comprehensive income”, respectively. And the fair values of all these, even held to maturity loans, should be disclosed at fair value in the footnotes.

Comforted yet?

By: OKJ1

OKJ1 — Thu, 03 Jun 2010 18:46:50 +0000

The very wealthy, i.e., Mr. & Mrs. Privileged Class (PC), simply don’t live in the same world as we do, i.e., Mr. & Mrs. Middle & Working Class (M&WC)…although each of them likes to think of himself as wearing the mantle of a Mr. Wise Everyman who…even though often quite wealthy…is still widely admired and respected by Mr. & Mrs. M&WC for his ability to “feel the pain” of Mr. John Q. Public, i.e., feel the pain of Mr. & Mrs. Average American (or European or Asian or whomever).

It is likely that the subject of this article thinks of himself in that way also. Likewise, the former head of the Federal Reserve. Likewise, the head of Toyota. Likewise the head of BP. Likewise “whomever”.

However, they feel neither pain nor guilt.

The fact of the matter is that these extremely wealthy people have forgotten what “pain” is (or never experienced it in the first place). Their view of the world is from a protective bubble. That’s just the way of it though. That’s simply a fact that cannot be changed.

If and when the wealthiest people in the world give away their wealth, we here at our M&WC Disabled Veterans’ Research Group (where “pain” is quite familiar) will take them and their financial and other prognostications seriously…and give them the respect and admiration that they crave—even more than they crave money.

By: Sensei

Sensei — Thu, 03 Jun 2010 18:33:35 +0000

Pricing the simplest of “options” is complex. I’m not sure how banks could appropriately account for the option value of a non-recourse mortgage AND also mark the asset to market prior to actual default. Bank balance sheets are opaque enough already.

Also, the higher the (required) down payment the less a mortgage looks like and behaves like an option – and the less need to price option risk into the rate. Put the borrower in first loss position and a lot of this goes away.

By: wcw

wcw — Thu, 03 Jun 2010 18:26:12 +0000

Thanks for the kind words. Worth noting, folks who analyze MBS pools do model both defaults, which captures these implied puts, and prepayments, the explicit loan calls every US mortgage contains. If MBS guys can, you would think banks already do the same. I am not an accounting-policy guy, but existing FASB regs should cover the event of a serious impairment via expected defaults. That would cover your mooted liabilities. I grant, we know banks are not always the best at marking down impaired assets, but off the top of my head I don’t think adding more accounting rules is the answer.

As for recourse, I would bet dollars to donuts that the bulk of underwater homes are not attached to borrowers with assets worth pursuing. You can spend a bunch of money to get your judgment, of course, but if your judgment is onerous, your debtors are going to wipe them out in bankruptcy anyway. Yes, a few banks may do this out of spite, but I can’t see it being a positive-NPV strategy in any but a few edge cases.

By: BPErickson

BPErickson — Thu, 03 Jun 2010 17:40:57 +0000

At least in Illinois, lenders very rarely pursue borrowers for deficiency judgments. That costs extra time and legal services on the lenders’ side, too, and unless the borrow has significant assets, it’s not worth the trouble. At that point, borrowers also have the option of declaring bankruptcy, since the debt owed to the lender is no longer secured. It is not so easy to collect.

By: MitchW

MitchW — Thu, 03 Jun 2010 17:18:40 +0000

I feel like it’s been well established that, in most states, lenders have recourse against borrowers. That should do a fairly good job of keeping the strategic defaults down since you can either 1) pay the loan or 2) pay the loan plus the legal fees if you have the assets worth going after.

By: MarshalN

MarshalN — Thu, 03 Jun 2010 16:58:09 +0000

But you and I and a lot of other people know that if the banks do that, half of them will be insolvent. The government won’t allow that to happen, so we are all merrily playing along as if nothing bad is going on and everybody is making record profits. It’s just a ploy to buy time for the banks to earn enough money to be solvent again. The financial system should’ve imploded in 2008. Now it’s been delayed because we are all paying for it via government debt. That bill, unfortunately, is coming due.