9% of mortgages are delinquent, some in foreclosure

The aggregate mark-to-market value of mortgage based securities has sunk far lower than the 9% deliquency number would indicate.

There is no current demand for the paper because people have no confidence that the good paper won’t turn out to be bad paper.

If there really is a crisis I wish someone would provide the step-by-step scenario that explains how a problem for a handful of big financial companies is a coming disaster for 300 million taxpayers. Show me how government inaction (usually a good thing) will cause A, which will cause B, which will cause C, which will cause Disaster.

The Washington Post and CNN-Money both report that smaller banks are thriving. My local banker is almost eager to lend me money on commercial real estate. I asked him about the credit crisis and he replied, “There is no crisis locally. [Name of bank] is alive and well with more than the required capital to be rated a well capitalized bank. We are here to lend and have money to do so.”

Devalued paper is created in a death spiral by the MTM and Debt/Equity rules.

The 9% is just the initial match.

I will write more later tonight.

Why do you blame the accounting rules and not the overlooked fact that the default rate has increased from 1% to 9% in a single year? Wouldn’t that be a sensible reason for the markets to distrust mortgage-backed securities, especially since the cost of a default is generally in the hundreds of thousands of dollars while profit from interest from good mortgages are only in the thousands (depending on the property)? In other words 9% seems small, but it is really HUGE because the loss of each of the 9% is HUGE compared to the gain of each of the 91%.

That’s the real reason.

According to the “mark-to-market” accounting rule, the value of a mortgage-based security is based NOT ON WHETHER THE UNDERLYING MORTGAGE PAYMENTS ARE BEING MADE , but instead on what the market is willing to pay for the particular asset at a particular instant of time.

The flaw in this argument is that what the market is willing to pay is a function of whether the underlying mortgage payments are being made.

In other words, even if Merrill Lynch holds a mortgage-based bond for which all applicable mortgage payments are being made on time and in full, the bond can still be valued at pennies on the dollar since nobody is interested, willing, or even able to purchase the bond.

Sure, but why would that happen? If this is so clear to you and me, then why are investors so worried? They should be diving in! No, a better explanation is not that savvy investors are stupid, but that they appreciate the devastating losses in the subprime mortgage markets.

This lack of logic in this situation is apparent to virtually anyone who stops to think about it, but the insanity of forcing financial institutions to dump their assets at bargain basement prices is the result of the mark-to-market accounting rule coupled with the debt/equity ratio regulations. These two factors more than any other, are the cause of the spiraling liquidity crisis.

No, they are forced to dump their prices at low prices because that’s what they are worth. Those two factors are not the fundamental causes of the liquidity crisis because if the mortgages and their derivative securities were still in bubble mode, there wouldn’t be a problem even though the factors you cite are still operative. The real cause of the liquidity crisis is the decline in the real value of the mortgage-backed securities.

Thinking that the cause is merely an accounting rule, rather than the documented deterioration in the fundamental conditions of the various markets due to the housing and now credit bubbles popping is wishful thinking.

Trying to re-inflate the credit bubble by artificially injecting more credit will work just as well as trying to re-inflate the housing bubble by artificially raising the prices of housing.

The market correction needs to happen. Let the banks fail.

Also, we can’t absolve those who got us into this situation. If we do we’re guaranteed to repeat it before too long.

In most industries, there are collection issues. Even a small business like mine loses a certain % of accounts receivable each year because businesses close, people go into bankruptcy, etc. In other words, companies frequently lose money on their least profitable customers/clients. In good years, the profitable clients/customers make up for the losses. In the bad years, many companies lose money in the aggregate and still manage to continue operations without a bailout or bankruptcy.

Losses at the Big Three have periodically been at or above the 10% mark and they have been losing money for several consecutive years. GM recently lost $27.33/share, a number that far exceeds 10% of the equity value of GM—and this happened after several years of significant consecutive losses. In contrast, the Financial sector was making a killing through 2006, and is now in need of government assistance because the number of delinquent mortgages has risen to 9%?

So why is the current crisis based on a 9% default rate such a crisis? Why is the financial system so vulnerable?

Blame the accounting rules!

According to the “mark-to-market” accounting rule, the value of a mortgage-based security is based NOT ON WHETHER THE UNDERLYING MORTGAGE PAYMENTS ARE BEING MADE , but instead on what the market is willing to pay for the particular asset at a particular instant of time.

In other words, even if Merrill Lynch holds a mortgage-based bond for which all applicable mortgage payments are being made on time and in full, the bond can still be valued at pennies on the dollar since nobody is interested, willing, or even able to purchase the bond. In the current panic-filled environment, people assume the worst and mortgage0based securities (i.e. bonds) are currently undervalued as a result.

Rational economic actors (such as individual home owners) choose to ride out the storm, and refrain from selling off assets at steep losses for the sole purpose of “getting them off their balance sheets.” In other words, if you bought a house for $500k you wouldn’t now sell it for $100k just because that is the current distress sale price for the asset. A rational person would tread water, and do what it takes to wait for the market to improve unless it was absolutely necessary to sell. Unfortunately, accounting rules essentially force sophisticated financial institutions to act in manner that you would characterize as stupid if it was your neighborhood home owner. They are required to value assets on the current market price, even if that distressed price is a bad deal and likely to be temporary. Making matters worse, such institutions are forced to either stop lending out money (essentially stopping the conduct of their business) or sell off the assets at very dumb prices in order to clear off their balance sheets. Financial institutions are limited by debt/equity ratio regulations, and thus are forced to either stop lending money or unload their bad debt at even worse prices.

This lack of logic in this situation is apparent to virtually anyone who stops to think about it, but the insanity of forcing financial institutions to dump their assets at bargain basement prices is the result of the mark-to-market accounting rule coupled with the debt/equity ratio regulations. These two factors more than any other, are the cause of the spiraling liquidity crisis.

As government officials contemplate the most expensive financial line item in U.S. history, you might want to consider the possibility that this entire crisis is the result of the “mark-to-market” accounting rule and that it may make more sense to change the rule rather than fork over $700 billion dollars ($2,400 per U..S. citizen)

Read the two articles below. The puzzling question to ask is why aren’t ANY politicians in Washington DC addressing this issue? A good follow-up question would be to ask why the talking heads on TV and radio haven’t mentioned the “mark-to-market” accounting issue as part of the public debate.

http://www.ftportfolios.com/Commentary/EconomicResearch/2008/9/22/heresaplantoavoidanew_rtc

http://online.wsj.com/article_email/SB122178603685354943-lMyQjAxMDI4MjIxMjcyODI2Wj.html

As I said over and over in public and private communications, I’d be perfectly willing to consider this bailout IF:

1. A bailout proponent can actually make a decent argument supported by facts and evidence as to why they think these subprime mortgage-backed securities will actually pay taxpayers back in the long run, considering the fact that we’re in a severe and continuing market correction of housing prices fueling continuing mortgage defaults across the country, which are precisely the things that give mortgage-backed securities any value whatsoever.

All I get are “it’s really reasonable” or “sensible” to believe that these “distressed securities” are worth a lot more than the market actually values them at. But what if the market is rationally apprehending the fact that the housing prices will continue to decline because they were propped up for so many years?

1. Paulson is fired. I know we can’t fire Bernanke and the elected representatives, but someone has to take responsibility for this and NO ONE HAS, so the American people are RIGHTLY not trusting the government.

2. Someone can explain how re-inflating the credit bubble by injecting more credit into Bad banks is a good idea when those foolish banks should fail and better ones take their place and their profits for doing a better job extending credit.