This whole mess should not be looked at as an opportunity to kill the wounded. Trust me on this one: if banks, there investors and the borrowers all go under, and that drives us deep into a recession/depression
This mess is not big enough for THAT impact.
I don't see it ... yes, lots of banks will go under (and they NEED to). BUT lots of banks did NOT get sucked into the caze. Smaller banks stuck to thier principals.
Just my opinion... but I don't think that there are a lot of banks that are going under if nothing is done... most have a good amount of capital and can absorb the losses...
I do NOT want any of my taxes to bail out anybody...
I think that we need to be a little more careful with language here. Actual banks mostly did not make the really hideously stupid loans that are going bad in droves. The worst subprime loans are the 2/28 loans that were very popular through early 2007. This structure has a fixed rate for two years, then the rate adjusts (higher, most likely). The idea is that after two years you have either fixed your credit, refinanced, or sold the house. Most of these loans were not made by actual banks that are backed by the FDIC (with a few notable exceptions). They were made by non-bank lenders who either sold the loans into the capital markets or held them and financed them. Why didn't banks make these loans? Because the bank regulators wisely held the banks to higher standards than the non-bank lenders, which meant that when the stupidest loans were being made, it was done by non-bank lenders because the regulators wouldn't let the banks be that loose. Some actual banks made subprime loans, but they generaly underwrote the loans a lot better and didn't make use of the 2/28 structure, so their loss experience has been much better.
And so who has blown up? Mostly, the non-bank lenders: New Century, Novastar, Saxon, etc. Actual depository institutions that blew up are few and far between. So I think that this demonstrates that bank regulations do work, if imperfectly.
What is putting pressure on all the banks now is that there has been credit market contagion that has spread throughout the mortgage market. The capital markets entities that financed a lot of mortgages (and not just subprime: prime jumbos, Alt A, etc.) have been shut down or hamstrung, and many of them ae being forced to liquidate in a stressed market. That means that banks that usually made loans and sold them in the ordinary course of business can't sell and ended up keeping lots more loans than they intended to. So these banks didn't (mostly) make droves of bad loans, they just ended up with a bigger balance sheet than they planned. Until they can delever a bit or sell some of these loans, many banks are pulling back on lending so as not to overstress their capital. And therein lies the problem for the wider economy. A widespread contraction in credit is a big damper on economic growth.
I see some signs that things are starting to loosen up a bit. I see some deals getting set up to sell or securitize some pretty squeaky clean loans (prime jumbos, etc.), so maybe this is a sign that the machinery of the mortgage part of the capital markets will get unstuck. I sure hope it happens soon, though, because we will all feel the effects pretty quickly if it doesn't get going soon.
The problems extend well beyond subprime.
Monthly Mortgage Rate Resets
I don't know what the proper resolution is but I think people should look at the chart at the link above and ask what the impact COULD be five years from now.
Let's dig for that pony!
Are there more home owners or more first-time buyers?
What difference is it to me if my house (on paper) goes from a market value of $400K to $350K, especially if I'm not selling?
Like I said, two things:
1) The wealth effect. People spend less when they feel less rich.
Yes, it will have an effect there. In the long run, I'm not sure that is a bad thing. If people never learn the dangers of over-extending, then why not always over-extend? That will lead to a super-bubble someday.2) Less equity extraction. People have been spending via home equity loans.
Maybe I feel a bit more immune to this as I don't bother to count my house equity in my 'net worth' - since I can't get an EOD or EOM quote on it at a click of the mouse, I just think of it as a little 'back pocket' insurance (if I downsize or reverse mortgage) on my SWR.
The problems extend well beyond subprime. I think it was Bill Gross who used a plankton analogy for subprime. Once the plankton dies, the entire ecosystem is affected. The subprime lenders are already dead. The Alt-A lenders are near death. Even the GSE's are hurting. They need to raise capital to meet their capital requirements, and that new capital is expensive in this environment.
But those are all first- and second-order effects. As brewer points out, an extended credit crunch would choke the economy. And combine that with depressed consumer demand, and you have a potentially lethal combo.
If a large number of ARMs were allowed to reset, there would be an increased default rate. Most of the current focus is on the new wave of bank write-offs that would lead to.
But that would also dump a bunch of REO inventory on an already saturated market. That would drive down prices for everybody, and we could start to see lots of "prime" mortgages upsidedown. This thing goes all the way up the food chain.
To the extent that these loans have been securitized and sold off to investors, it is no longer the lender's prerogative to renegotiate the terms of the loans. I am not familiar with what is presently being proposed in terms of a bailout, but if the government is suggesting that securitization trusts be denied the ability to exercise their remedies for the "greater good," this would be a truly astounding move.
And it is hard (impossible) for the gvmt to change a contract after the fact... so it seems like a lot of wind being spent for something that might not happen..
Yup, I think you've hit on the hitch in the plan. Work-outs involve contract modifications. Massive automated work-outs are unprecedented. It'll be interesting to see how (or if) they actually implement this.