On one level, we know that the $700 billion taxpayers are being asked to cough up is going to investment banks, the institutions that have gobbled up the remains of investment banks, and wherever else Czar Paulson decides to pull out his checkbook. But what are those institutions using the money for? Because there's a little problem with the math.
This crisis was brought to you by subprime mortgages. We know that because we're told it many, many times each day. So how big is the problem?
The total value of all home mortgages has risen steeply over the last few years as the housing bubble drove home prices up and lax lending rules roped more people into the pool. Home mortgages were valued at $7 trillion in 2003 but were up to $11.1 trillion by last year.
How many of those were "subprime?" It depends on how you define it. Funny thing: the initial definition was loans that didn't meet Fannie Mae or Freddie Mac qualifications, meaning that those institutions shouldn't be holding any subprime loans. But as a term, subprime is now more often applied to any loan where either the applicant's credit fell below the mid-range of "good" or where the lender did an abbreviated credit check. That kind of loan really came and went rather quickly. They were 8% of loans in 2003, topped out at 20% of loans in 2005 and 2006, and were back to 3% of loans in 2007. According to the Joint Center for Housing Studies at Harvard, $139 billion of subprime loans were handed out in the last quarter of 2006, but this was down to $14 billion in the matching quarter of 2007
Now the real question: how many of those loans are in trouble?
Foreclosures were up a steep 79% in 2007, reaching just over 1% of mortgages. The numbers are up again so far in 2008 (though not as steeply). We could top 2% in default this year or next. There are some expectations that foreclosures could triple from today's historically high levels, meaning ultimately 3% of mortgages could be in trouble.
And that's where we get that math problem. 1% of all mortgages -- the amount now in default -- comes out to $111 billion. Triple that, and you've got $333 billion. Let's round that up to $350 billion. So even if we reach the point where three percent of all mortgages are in foreclosure, the total dollars to flat out buy all those mortgages would be of what the Bush-Paulson-McCain plan calls for.
Then we need to factor in that a purchased mortgage isn't worth zero. After all, these documents come with property attached. Even with home prices falling and some of the homes lying around unsold, it's safe to assume that some portion of these values could be recovered. In the S&L crisis, about 70% of asset value was recovered, but let's say we don't do that well. Let's say we hit 50%. Then the real outlay for taxpayers would be around $175 billion.
Which, frankly, is a number that Wall Street should be able to handle without our help. After all, the top firms on Wall Steet payed out $120 billion in bonuses alone between 2000 and 2006. If they've got that kind of mad money, why do they need us to step in now? And why do they need twice as much as all the mortgages that are even likely to implode?
In going for $700 billion, what the Bush administration is saying is:
- Our pals on the street have been very creative in coming up with instruments in which they've entangled bad mortgages with good mortgages, and rather than untangle them, would rather we keep them from all that difficult paperwork.
- Oh, and while we're at it, we might as well buy up a chunk of the swaps and derivatives that were created in an unregulated shadow market so they could double-triple-quadruple dip on the value of these loans.
Handing out $700 billion wouldn't be buying up the mortgages of home owners who got in over their heads, it would be buying up the excesses of executives for whom even subprime loans weren't enough. A sensible solution would be to hand out less money -- maybe $100 billion -- to address mortgages now in default, and authorize bankruptcy judges to negotiate on the terms of mortgages on primary residences. On those renegotiated mortgages, the $100 billion fund could be used to pick up some portion of the difference between the original and revised terms. Used that way, $100 billion should cover every mortgage that fails for the next decade.
And if they need more help than that, if that didn't solve the problem, then practitioners of "creative" finance have to fess up that they can't make it because of their own malfeasance, not because some home buyers bit off more than they could chew.
What Are We Buying?