Re: on the financial meltdown

[David Farber <dave () farber net>]

Begin forwarded message:

From: "Ronald J Riley \(RJR-com\)" <rjr () rjriley com>
Date: October 16, 2008 7:15:32 PM EDT
To: <dave () farber net>
Subject: RE: [IP] Re:   on the financial meltdown


Dave, for IP if you wish.

I am anticipating that the financial crisis will lead to a greater
dependence on land contract sales.  One problem with land contracts is  
that
sellers have been known to be leveraged in the same way as the banking
industry and are unable to convey a clear deed to the buyer.  It is
important that buyers insist that the contract prohibits the seller from
encumbering the property or if there is an existing lien that it be paid
down proportionate to the payments which the buyer is making..

Ronald J. Riley,


Speaking only on my own behalf.
Affiliations:
President - www.PIAUSA.org - RJR at PIAUSA.org
Executive Director - www.InventorEd.org - RJR at InvEd.org
Senior Fellow - www.patentPolicy.org
President - Alliance for American Innovation
Caretaker of Intellectual Property Creators on behalf of deceased  
founder
Paul Heckel
Washington, DC
Direct (202) 318-1595 - 9 am to 9 pm EST.


-----Original Message-----
From: David Farber [mailto:dave () farber net]
Sent: Monday, October 13, 2008 11:21 AM
To: ip
Subject: [IP] Re: on the financial meltdown



Begin forwarded message:

From: Tom Gray <tom_gray_grc () yahoo com>
Date: October 12, 2008 7:50:16 PM EDT
To: dave () farber net, tom_gray_grc () yahoo com
Subject: Re: [IP] on the financial meltdown


Prof Farber

The original posting indicates that a great many people will be  
walking away
from mortgages on homes where they have negative equity.
This leads to the question of where these people will live. They have  
middle
class salaries and middle class expectations for housing.
However, they will have ruined their credit with their choice to walk  
away
and only a faint, if any, hope of getting another mortgage.

There are not large numbers of middle class level apartment buildings  
with
vacancies ready for poor credit risks. The choice for people who have
negative equity but can finance their payments could be rather stark.  
They
can pay off their mortgage or they will be essentially homeless.

===========================

Additionally, if the money that is being created by the government to  
fix
the problem merely replaces the money that has vanished with the bubble,
then no new net money is added to the system. This is not  
inflationary. The
problem now is deflation not inflation and that is a much worse problem.

Thanks

Tom Gray


--- On Mon, 10/13/08, David Farber <dave () farber net> wrote:

> From: David Farber <dave () farber net>
> Subject: [IP] on the financial meltdown
> To: "ip" <ip () v2 listbox com>
> Date: Monday, October 13, 2008, 3:14 AM Since this is so long Mark's
> reply Mark is an OLD , in time not age, Wall Streeter who was involved
> with taking Apple public.
>
> Dave
>
> Date: Sun, 12 Oct 2008 13:00:36 -0400
> From: Mark Stahlman<newmedia () aol com>
> Subject: Re: any comment on this?
>
> Dave:
>
> Andrew is much better on telecom! <g>
>
> Clearly "stabilizing" home prices is very important.  In addition,
> giving those people who are "under-water" on real estate need time to
> let all this happen.  This is pretty well known and in the headlines.
>
> No one -- including the US Treasury -- actually knows what they will
> do with the $700B.  That's one of the reasons why it was so hard to
> pass in Congress.
>
> We are in a FINANCIAL crisis and will probably be in one for 6-12
> months.  However, Andrew has failed to illustrate what the ECONOMIC
> consequences are likely to be.
>
> The "problem" is the old rules are gone and new ones haven't been made
> up yet.  So lots of people are on the sidelines waiting to see what
> the new rules are going to be.
>
> What I'm most interested in is the *permanent* changes in consumer
> behavior that this will provoke and how that will change the direction
> of the global economy.  Yes, it's way too soon to know.
>
> Mark
>
>
>
> Begin forwarded message:
>
>
> From: odlyzko () dtc umn edu (Andrew Odlyzko)
> Date: October 10, 2008 11:24:50 AM PDT
> To: dewayne () warpspeed com
> Subject: on the financial meltdown
>
>
> Here is a little economic model that may shed some light on what's
> happening to the financial system, why Paulson's recent $700 billion
> plan may very well be the wrong solution, and why the whole problem is
> very hard to solve.
>
> Suppose your Aunt Millie and her husband retired two years ago from
> their jobs in Palo Alto, and decided to move back to their native
> Omaha.  They sold their little shack, bought for $50,000 many decades
> ago, for $1 million (two years ago being the peak of the real estate
> market, and Palo Alto shacks being pretty pricey even now).  Suppose
> the mortgage had been paid off a long time ago, so she and her husband
> owned the house outright.
> Now
> by traditional measures (prices compared to household incomes,
> say) that Palo Alto shack might have been worth $500,000 (as Palo Alto
> is a desirable place to live, and there is very little land that can
> be developed in the vicinity).  But with the runup in real estate
> prices, it was valued at $1 million two years ago, and she got that
> price.
>
> After paying realtor's commission, capital gains taxes (the home
> capital gains exclusion only covers $500,000 per couple), etc., they
> might be left with $800,000, say, of which they use $300,000 to buy a
> big house in Omaha, and put the remaining $500,000 into a CD in a
> national Bank Too Big to Fail (BTBTF).  Note that realtors and other
> agents got a large chunk, say $100,000 (just to keep to round
> numbers), and the governments did not do too badly either.
>
> Now further let's suppose that your Cousin Jim, not knowing of the
> relationship to your Aunt Millie, was the person who sold the Omaha
> house to Aunt Millie, and bought her house in Palo Alto, not knowing
> of the relationship, and not knowing he was dealing with the same
> person in both cases.  Say he also owned his Omaha house outright, and
> of the $300,000 he got, after paying various fees, commissions, moving
> expenses, etc., (and this is important, as the real estate bubble
> enriched many people, not just the homeowners) had $250,000 left, of
> which he spent $50,000 on some new furniture, and put $200,000 down on
> that $1 million shack of Aunt Millie's in Palo Alto.
> The
> remaining $800,000 came from a mortgage from the Bank Too Big to Fail
> (BTBTF), the bank that has Aunt Millie's $500,000.  Now putting 20%
> down was absurdly conservative at the peak of the real estate bubble
> two years ago, but it helps make the model more realistic, in that
> BTBTF would have had other mortgages as well, some from years ago,
> which supposedly have a lot of homeowner equity in them.
>
> Now the Bank Too Big to Fail (BTBTF) did not keep that $800,000
> mortgate of Cousin Jim.  It sliced and diced it, and sold it off
> (after mixing it up with other mortgages) to other institutions.
> Say there were 4 tranches into which Cousin Jim's mortgage was
> divided, each for a nominal $200,000, with slice A having first claim
> on any mortgage payments from Cousin Jim (or from auctioning Cousin
> Jim's Palo Alto shack if it goes into foreclosure), slice B having
> second claim, etc.  (This is not a correct representation, that's not
> how mortgages were packaged, but it has the key elements of that
> wonderful "distribution of risks to parties able to bear it, and
> enabling home ownership" machinery that was operating, so let's go
> with it.)  And then those 4 tranches of Cousin Jim's mortgage went on
> some wonderful trips, being further sliced and diced, having their
> grades improved by credit rating agencies, etc.  And suppose that by
> some miracle all the trenches ended up with BTBTF.
> But
> before they came back, perhaps $100,000 had been extracted from them
> to pay the mortgage brokers, lawyers, Wall Street investment banks,
> and of course the management of BTBTF, which showed such great
> brilliance in minimizing risks and maximizing profits for BTBTF's
> shareholders.  So now BTBTF has again the entire mortgage for $800,000
> on Cousin Jim's house, but it is probably valued on its books at
> $900,000, when you get down to it and examine all the financial
> details.
>
> Now suppose that the Bank Too Big to Fail (BTBTF) has on its books
> just that mortgage to Cousin Jim, valued at $900,000, and standard
> commercial loans for $1,100,000 to various companies, say a local car
> dealer, restaurant, etc..  (Yes, $2 million is not enough to make a
> bank too big to fail, it's not even enough to pay for legal fees to
> establish a bank, but I am just trying to keep things simple, BTBTF
> would have closer to $1 trillion on its books, but then Cousin Jim's
> mortgage would be swamped by all the other accounts.) And suppose that
> BTBTF has $200,000 in capital, and $1,800,000 in deposits, Aunt
> Millie's CD for $500,000 included.  By conventional banking standards,
> that is extremely conservative, 10% capital is just great.  But these
> are not the usual times.  Real estate prices have come down quite a
> lot.  Say they are down by 20% in Palo Alto.
> (I have no idea of what the actual decline has been in Palo
> Alto.)
> But that is just what realtors say, the market is pretty much frozen,
> and if Cousin Jim had to sell his home today, he might have to settle
> for just $600,000 in a quick sale.  And prices are going further down.
> So for the moment Cousin Jim is still paying his mortgage.  He has his
> job (at least for the moment), and he has hopes that the value of his
> shack will go back up to to $1 million, or at least not go down below
> $800,000.  But if it does go down further, and he is rational, he will
> hand the keys over to the bank.  And then the bank might have to sell
> Cousin Jim's shack for $600,000, which will leave it with a loss of at
> least $200,000, and more likely $300,000, if proper accounting is
> applied to all the financial maneuvers that had taken place.  That
> will wipe out its capital, and possibly more.  But what if the price
> the bank can get is even lower?
>
> Until recently, the actions of government agencies, both in the U.S.
> and other countries, seemed to be based on the assumption that there
> would be only a modest decline in housing prices, and so all they had
> to do was keep people from panicking.
> If
> Palo Alto housing prices only go down 20% from their peak, Cousin Jim
> will keep paying his mortgage.  Perhaps a few of his neighbors who got
> 100% mortgages with montly payments that have just reset to levels
> they can't afford will walk away, but if the effect is small (say
> BTBTF has only 10% of one of those mortgages, and the total loss on
> that mortgage is going to be $250,000, then BTBTF will lose $25,000,
> which is a painful hit to its capital, but not fatal) then nothing
> serious will happen.
>
> But now the general impression in the markets seems to be that the
> housing price declines are going to be more serious.
> Suppose
> that prices go down to levels consistent with historical ratios of
> house prices to incomes.  (And they could go down below that, of
> course, historically this ratio has oscillated.  Note that the
> situation is worse in many countries than in the U.S., since those
> countries, including Ireland, had a more severe housing inflation than
> the U.S. did.  The crisis started in the U.S., but that could be the
> result of several factors such as (i) our investment banks being the
> most leveraged, and (ii) our system being the most
> transparent.)  What would that mean?
>
> Over in Omaha, Aunt Millie and her husband might see the value of
> their $300,000 home go down to $200,000.  (Inflation was generally
> lower in the Mid-West than in California.)  That is not that much of a
> problem, since they own that house outright.  They are probably scared
> about that $500,000 CD at BTBTF, since the amount is over the limit
> insured by the feds.  In practice, it seems pretty clear that the feds
> will cover them for the entire amount, as several countries have moved
> to do.  But in the meantime, they are probably more than a little
> scared, and less willing to spend, helping push the economy deeper
> into a recession.
>
> But in Palo Alto, if the price of Cousin Jim's shack goes back to the
> historical trend of $500,000, he will hand the keys to the bank,
> sooner or later.  (Sooner if the recession kills his job.) So where
> does that leave BTBTF?  If it gets Cousin Jim's shack and has to sell
> it, it will likely get only around $400,000 for it.
>
> That means BTBTF is effectively bankrupt, since it has only $200,000
> in capital, and the loss on Cousin Jim's mortgage will be $400,000 or
> $500,000.  Unless Paulson, using taxpayer money, overpays by an absurd
> amount, there is no way that BTBTF can break even.
> Yes, if
> the free-marketer Paulson decides, in his wisdom, that the free market
> is grossly incorrect, and that the Palo Alto shack is going to be
> worth $1 million in a couple of years, he might pay $800,000 for the
> mortgage on Cousin Jim's shack, arrange for it to be rented, and sell
> it at the proper time for a profit for taxpayers, and great glory for
> himself.  But any realistic price he pays for Cousin Jim's mortgage,
> or pieces of it, will still leave BTBTF under water.
> There is no way that BTBTF management can make the bank healthy
> enough, unless either (i) real estate prices recover (which is not
> absurd, rapid inflation, something that "helicopter Ben"
> Bernanke had talked about in the past, might be resorted to by the
> government), or (ii) BTBTF management take wild chances, like taking
> all the cash in the till and wagering it on a roll of the roulette
> wheel in Las Vegas (basically what the S&L's did in the 1980s, when
> they were in a similar situation, and put lots of money into crazily
> speculative investments).
>
> Putting actual capital into banks (basically what Swedes did in the
> early 1990s, and the British are doing now) seems to be the only way
> to get the financial system moving.  That way management (and
> unfortunately, since we can't start from scratch, it means pretty much
> the same management that got our financial system into the current
> mess) will have incentives to loan money in the traditional ways, that
> sustain the normal functioning of the economy, and not wager it in a
> casino.  But the amount of money that would need to be put into banks
> for this to work will have to be huge.  It would basically have to be
> enough to cover all the losses on all the loans they have made (which
> we can't estimate precisely, since we don't know how bad the recession
> will be, and how many other bombs are going to explode.  This is in a
> way not all that dissimilar from Paulson paying absurdly high price
> for Cousin Jim's mortgage, but it would give taxpayers a better chance
> to recover their money, and provide better incentives for bank
> managers to behave prudently, yet perform their key function in the
> economy.
>
> Note that the fundamental problem we face is less the $200,000 that
> the mortgage brokers, lawyers, Wall Street investment banks, and
> management of BTBTF got out of the Aunt Millie and Cousin Jim
> transactions.  It is rather the $500,000 that Aunt Millie and her
> husband got for their shack above what the likely long-term value of
> that shack is.  They did not do anything wrong, all their actions were
> perfectly legal and moral.  But they were the beneficiaries of the
> real estate bubble, and at least in the short run they are likely to
> escape unscathed, and without any blame attached.  In the long run, of
> course, they will have to help pay for the cleanup, either through
> higher taxes, or through inflation.
>
> Sorry this is so long, but it seemed about the shortest model that,
> even though grossly simplified, still showed what seem the essential
> features of our current crisis.
> RSS Feed: <http://www.warpspeed.com/wordpress>
>
>
>
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