Unregistered

hi,

of course I hope David could comment on that, as like i said i know about this crisis only from newspaper and did not study it as such.

i wrote the comment above but forgot to sign.

tomek

David Waring

Hi Tolek,

Thanks for the comment.

In a broad sense the difference between Enron and the current situation is that Enron was using off balance sheet entities to hide debt where at least so far no bank that I am aware of has been accused of trying to hide any debt via these SPV's.

You are correct in my view that once transfered over to the SPV the liability was off the bank's balance sheet. The answer to your question however lies in the fact that the banks essentially transfered it back onto their balance sheets by acting as the lender of last resort to the SPV's.

I don't think that this fact was fully understood by the regulators and the market before hand so it will be interesting to see what happens as a result of that down the line.

Best Regards,
Dave

Sherry

Thanks David for a good explanation. I'm in Canada and we haven't been affected in the same way due partly to the fact that our financial institutions have lent money a lot more conservatively.

One thing that I've wondered watching the situation in the U.S. is why everyone wants to bail out the banks. Haven't they brought this on themselves through foolish lending? While I do believe that everyone is responsible for the decisions they make, I'm sure those banks were out there "selling" those loans to sub-prime lenders and trying to get the maximum mortgage sold for each client - luring them with these mortgages that the banks should have known the lenders couldn't afford.

Aren't the banks just getting what they deserve for being greedy?

David Waring

Hi Sherry,

Welcome to the community and thanks for the comment.

I think that you will find that if you speak to the average person in the US they will tell you that they are in agreement with your line of thinking that the banks brought this on themselves and therefore should be left to suffer the consequences.

One thing that I don't think is fully understood by those who make that argument however is how much they would be affected if a bank the size of Bear Sterns was allowed to fail. Remember that a bank is not like a car company or a large retail store who if they go out of business no one is really affected save the people directly related to the company. If a bank that size is allowed to fail in the current environment it would most likely freeze up the credit markets potentially causing a financial meltdown the size of which we have not seen since the great depression. This would affect not only US citizens but people all over the world.

So while I don't think there are any 100% right or wrong answers on this one I think there are strong arguments on both sides and if there are other takes on this I encourage them to be posted below.

Best Regards,
Dave

nik154

Hi Dave,
An excellent video lecture.

Question !
I am some XYZ bank who has bought **** loads of mortgage backed securities, Now if people have started defaulting (On home loans that they had taken), i get to keep their houses which was a collateral in this case. So ultimately what I land up is a lot of real estate assets. Now in spite of declaring a write down or a loss shouldn't i wait for real estate market to rise and sell of those houses to cover up my losses ( assuming the fact that real estate prices are cyclic) ?
And if at all i am decalring a writedown of lets say 1b$ (that should be equal to the fall in prices of the collaterals i had eg. 1000 houses each falling by $1m value and hence a 1 b$ writedown )

Thanks

David Waring

Hi Nik154,

Glad you like the videos and welcome to the community.

Theoretically the entity that owns the house after the foreclosure could hold onto the house and wait for the market to recover. There are two issues with this however. The first is that while housing prices have always gone up over the long term there is no guarantee that they will continue and even it there was because we are coming out of such a large bubble in the housing market it could be many years before the value of those houses recover. So with this in mind most financial institutions would prefer to just sell off those assets so they can then use the money that is tied up there to seek out new profit opportunities.

The second thing here is that as I lay out in my video on mark to market accounting and the subprime crisis, accounting rules require that the firms holding these pools of debt mark them to market or in other words hold them on their books at current market value. So with this in mind even if they held onto homes that people defaulted on they would have to record whatever losses they were taking as a result of those defaults and write them off against earnings now.

As to the second part of your question the fall in value or the write downs that the banks are taking are a result of the decrease in value of the loans that make up that specific pool of mortgages. So this decrease in value could come from 1. existing people who have not made their loan payments 2. People who have defaulted completely or 3. A decrease in value that comes from the number of people who have not yet defaulted but are expected to.

Hope that makes sense and if there are any other questions or comments on this please feel free to post them below.

Best Regards,
Dave

jtan

Hi, u mentioned something about the writing down of losses and i was wondering why is it difficult to put a value on these losses. could you explain further? or would there be recommended readings on these losses that i can read up to find out more? btw, thanks for the information!

David Waring

Hi Jtan,

Thanks for the comment. Have a look at the below post and let me know if this does not answer your question.

Valuing Subrprime Losses

Best Regards,
Dave

Unregistered

Hey, thanks a lot for this lesson. It is really quite exhaustive and has gone a long way in improving my understanding of the subprime crisis.

David Waring

Hi there. Thanks for the comment I am glad you liked it.

Best Regards,
Dave