And they deserve to pay.
The idiocy I've seen in the past 4 years is unbelievable. How banks will gladly throw quality out the window, ignore credit, and finance the most outlandish ventures just to keep sales going like it was 2004. How they will bend over backwards to finance a $10 million real estate deal because they get a 1% commission even though that deal stands a nice-guy's chance of scoring with a girl in college than ever paying back the money. And how they're so desperate to keep the top line of the income statement going up they've lowered their standards to pursue sub-prime people with credit scores of 550 or less which as they're finding out is driving their bottom lines down.
And now the time has come for the housing market to collapse and to slowly erode what banks have been lending on this entire time, real estate.
It was about 4 years ago now that The Economist pointed to the possibility of a housing bubble. I often opine if these financial institutions had hired an economist, or heck, just read the freaking Economist, just how many hundreds of billions of dollars would have been saved, not to mention the more-than-likely-recession we're about have would have been staved off. But the banks have been so obsessed and addicted to the sales growth of 2001-early 2005, they just can't stop and consequences be damned. Like heroin addicts, like Gene Hackmann in The French Connection, they're rabid for new loans. And they don't care about the quality of the loans, they just want volume.
Of course there is a penalty for ignoring the long term consequences for short term gain. As housing prices drop the collateral these banks are holding will become impaired (I even remember recommending to a client that they change their advance policy from 80% appraised value of real estate to 70-75%, I was laughed at). And as these values go down their clients, who are all already over-leveraged to begin with, well be unable to unload the glut of property they now hold and therefore pay back the loan.
Addtiionally, an emergency back up measure for these instances is also no longer available. Primarily used by gluttonous, lazy, non-working "millionaires" is if they couldn't sell the property, in order make current loan payments was to borrow more money from the property as property prices went up, giving them more equity to cash out/bleed out of the property. Well when prices stagnate or go down, this technique won't work.
Thus what is going to happen is the banks are going to be left holding the live grenade. They will be holding a vast portfolio of real estate that they can't unload...or at least unload to cover their original loan amount. And they might as well not even bother repossessing because they'll do no better job selling it than the developers and bulders themselves would. And so they get to play "Japanese Bank Circa 1980's, "perpetually financing a zombie real estate industry that has no hope whatsoever of repaying them back.
The question is how exposed are banks to real estate and thusly how big of a problem this will be for the banks in the next 12 months? I mean, certainly banks have been wise enough to diversify their portfolios. Spreading it across industrial loans, agricultural and other sectors of the economy. Certainly these highly educated and experienced financial gurus would follow this basic "Principals of Finance 101- Diversification" rule? Right?
(I do know that I did adjust the scale on the left side, which I normally am against, but the average was 44% and I just wanted to show how much of a deviation occured from norms)
The piper SOOOOO has to be paid.
And it would have been a lot cheaper to pay an economist.
I am as worried as you are. But commercial bank loans used in leveraged buy-outs are also a significant concern. Might we get into a worst than expected recession, corporations with large debts are likely to default. Its is not so bad when they default on their bonds, but if we get a string of companies defaulting on bank loans, the government will have to bail out the banks. Once the banks are on welfare, they can afford to keep bad loans (like Japanese banks did in the 90s). That would be really dangerous for the longterm health of the economy.
ReplyDeleteOne big difference between mortgage defaults and corporate defaults is that salaries are sticky but profits are not. For the average homeowner, a recession means 5% chance on losing your job, but 0% risk in having your salary reduced, thus 5% default rate on mortgages (because people hold on to their houses when they can't "break even" selling them, as long as they can still make mortgage payments). For a company, a recession usually means less profit or a loss. This translates into less or no dividends for companies financed with stock. For companies financed with debt, this means perhaps not being able to make their interest payments.
ReplyDeleteSo it is somewhat reassuring that the bulk of bank dept is in housing, since this makes a government bailout less likely.
Whoa, what are you, a liberal???
ReplyDeleteWhat ever happened to BUYER BEWARE???
Don't forget about people like me who use non-standard (arm, interest-only, etc) loans in order to do our business. We are smart enough to realize what we're purchasing, use them short-term, and for me and those I know, it's worked out just grand.
Just because some random assholes didn't know how to manage their banking doesn't mean the lending institutions are to blame.
Connie
P.S. I love foreclosures. Bring 'em on, cuz I'm ready to buy.
Banks would end-up in serious trouble on mortgages in one of two ways. Way 1: high inflation allows real salaries to go down without changing nominal salaries, which would make the bulk of the population poorer in real terms. Way 2: demand for housing drops considerably (because of a population decease likely caused by a pandemic), thus house prices plummet by more that 25%, making defaulting on your mortgage an interesting option. I'm done now ;-) .
ReplyDeleteIf all of what you say comes to pass, I have to say I'll be buying a condo or something somewhere at a REALLY LOW PRICE!!
ReplyDeleteJunam