How’s It Happen?

That last post has me pre-occupied.  I think the two graphs and the statement by Yun are dramatic.  I keep asking, ‘How can this be?  How is it in a time when most Americans have taken a 50% or more hit on their home equity (which is, for most, the biggest nest egg they have), that the Financial Industry is doing so well?’  I mean:  aren’t these the guys who got saddled with all of these upside down loans who now have to cash them out for far less than they have in them?  How is it they can be so profitable at a time like this?

I don’t claim to be an expert.  I certainly am not.  I tend to see complicated things simply, often missing the many nuances.  And I don’t know the big answer to the question, HOW.  But I know one of the ways.  When Banks were failing right and left, the FDIC stepped in seized the assets and guaranteed the deposits (thank goodness!).  Because the FDIC is not in the banking business, they then turned around and sold those assets to other banks.  Among the assets were usually a big stack of bad loans, mortgages where the property was worth far less than the amount of the mortgage.  Wow!  How do you get somebody to buy something that’s worth-less?  How about incentives and discounts.

So let’s assume that Bank A fails.  The FDIC steps in and seizes the assets, including one $300,000 mortgage on a property currently worth $250,000.  They then sell that mortgage to Bank B for $235,000 – which is the discount part (since the property is worth $250,000, they transfer the asset at a discounted value that makes sense to Bank B).  Here’s where the incentive part comes in.  Because we are in a declining market, the FDIC goes on to guarantee Bank B’s losses on the mortgage.  They say, if you take a loss on this loan, we’ll cover you up to 80% of your losses.  Hey, now this is sounding a little safer, a little better.

So Bank B goes on and forecloses on the mortgage (let’s not even consider the impact on the foreclosed family, their neighbors, area values and the economic climate).  They ultimately sell the property for $220,000 to an investor.  So you think:  they paid $235,000 and got $220,000.  That’s $15,000 in loss and the government is going to cover 80% of that, which is $12,000, so Bank B’s net loss on the deal is $3,000.  That’s ok, we all have to do our part, and they probably made a little on servicing or something.

But that’s not the way it works.  The ‘loss’ is calculated NOT from what Bank B paid for the asset but from the face value of the asset:  $300,000.  The ‘loss’ is the difference between $300,000 and $235,000, $65,000.  And 80% of that is $52,000.  Bank B gets $220,000 when they  dispose of the asset plus $52,000 from the government (which is, by the way, you and me), so their take is $272,000 on a thing they paid $235,000 for:  a net of $37,000.

I don’t know about you, but I’d take that deal all day long.

The infuriating thing is that We The People can’t afford this.  We’re borrowing from the Chinese to pay for the stupid deals we made.

Here’s a little PR Fluff from the FDIC about this:

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