Thursday, September 06, 2007

Who Wins in the Housing Bust?


Frequent contributor Albert T. has often alerted us to below-the-radar factors--for instance, the Basel II banking regulations which are roiling global financial markets just as he predicted over a year ago:
Basel II, Risk and Leverage (July 11, 2006).

For just one example of Basel II's effects, take the smaller German banks which are taking huge losses in U.S. subprime-related losses: Banking bother .

Albert has a new line of inquiry:


Right now I am trying to answer one question... Who won in the housing bust?

1. Small banks. Since I am more or less constantly look for jobs lately I notice several odd things: A lot of credit officer / credit analyst training programs and entry-level positions in small banks in my area. Which is making me think they are having a boom. And the reality is they probably offloaded all their garbage to big banks who preferred to repackage securities.

2. Prudent homeowners who sold out. The prudent homeowner whom toiled away and paid for the house he could afford for a decade or two until he sold it to the bubble junkie supplied by the neighborhood dealer (broker).

3. Everyone on the other side of the losses/trade. The figure I am thinking of is not 200 billion but closer to 1.5 trillion if we take the last 3-5 years of loans and discount all ARMs and exotics by 20 cents and normals by 10 cents we come to something around 1.5 trillion of losses (transfers) since there is always the other side.

4. Domestic banks. I am guessing at least half of these transfers are borne by foreigners in some way. The other half is carried by our biggest banks and brokers who are going to slowly digest it over the next 3-5 years unless they get a handout to accelerate the process.

The benefit of our banks as opposed to others is two-fold: on the one hand they have no currency risk and the Fed can supply liquidity at will, on the other the winners are probably depositors as well so their liabilities (deposits) bulk up against the banks assets (bad loans) and allow the aggregate income to eat away at them. Although some foreign banks probably benefit as well due to having large operations here which makes it easier for them to survive the upcoming shock.

5. Buyers of bank assets after the banks fail. Shock is probably when the income stream begins to dry up from the asset sheet (ergo MBS securities, etc...) when the net flow payments turns negative there will huge upheaval (but probably prior to that those banks will be dissected and bought up with bad parts left to fail and the large loss taken by the govt or populace (which is more or less the same thing).

Freddie Mac's net drops 45% on provisions .

6. Society at large. perhaps we all win once we get to reality and property stops being the objective of people and be all and end all social status. perhaps we will focus on a different set of things once full collapse of housing prices is in order.

7. Re-Ordering of employment to the public good. perhaps unwinding of risks and their slow digestion will benefit us in the long run somehow although udnoubtedly a lot of suffering will occur. I am sure there will be lots of job cuts in big brokerages & banks once losses start coming in. it might perhaps trigger some of those smart people to start businesses. if you search right now any job site with the word "quantative" there will be a zillion hits with offers from every financial firm out there but maybe those people would serve better as math teachers, engineers, physicists, etc... since that is whom they look to for quant analyst candidates.

Thank you, Albert, for a stimulating review of upsides to the housing bust. Although some may doubt that small banks and credit unions might prosper in such troubled times, I know from conversations with executives in a small, locally-owned and operated midwest bank and a Virginia-based credit union that they have virtally no exposure to subprime or derivative losses. As old-fashioned as it sounds today, they write their own mortgages and hold them as assets. Since they planned on holding the debt, they were careful in their assessments of value and risk when originating the mortgages. What a concept, eh?

I leave you with a chart which depicts the dire straits we face as a nation of borrowers and lenders:



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