The Problem is the Assets
I'm generally a big fan of Matt Yglesias, but this post makes no sense. Matt writes:
Second, the assets at issue here are the mortgages (and mortgage-backed securities), not houses. The house or property is merely the collateral on the loan. A mortgage or a mortgage-backed security is an asset, not a liability. It is, essentially, a right to payment of a certain amount over a certain period of time. The problem is that people are defaulting on their payment obligations (i.e. falling behind on their mortgages), and so the expected money stream is not flowing into the banks. And the collateral on the mortgages (the property) is now worth significantly less than when the mortgages were issued, meaning the owners of the assets generally cannot recoup their money by seizing the collateral (i.e. initiating foreclosure).
The end result of all of this is that these mortgages and mortgage-backed securities (assets) are worth a lot less than the banks thought they were. And because the market for these assets is so illiquid, their actual value is very difficult to determine.
To put it yet another way, banks are holding a lot of assets that no one wants (hence "toxic") and therefore those assets have current market values that are only a fraction of the value the banks have assigned to them on their books. The real question is whether these assets are being undervalued at the moment (because the market is panicked and not functioning properly) or whether their current market value represents their actual value. If the latter, then most of the big banks are almost certainly insolvent. If the former, then conceivably the government could step in and buy all the toxic assets at their "real" value, hold them for a while, and sell them when the housing market stabilizes and a functioning market for mortgages and mortgage-backed securities re-emerges. Even under the latter (very optimistic) scenario, the banks may still be insolvent if the "real" value of the assets (i.e. the price the government is willing to pay) is less than the value assigned to them on the banks' balance sheets.
Whatever the case, though, the problem is that the banks are holding a lot of assets that no one is willing to purchase at anything close to the value the banks have assigned to them on their books.
I think an ordinary person reading that sentence would think that the problem with Citi is that some of its assets are somehow “distressed” or “toxic” in a way that’s causing a problem for the rest of the bank. Take the toxicity off its hands, and the rest can go merrily about its way. But that’s not right. We can argue ’till the cows come home as to what the assets in question are “really” worth, but at a minimum they’re worth $0. And in practice they’re sure to be worth more than $0. Assets with a positive value can’t be a problem for a company. A company gets into trouble because of its debts. Citi’s problem isn’t that it has toxic assets, it’s that it made loans backed with toxic assets.This is wrong on multiple levels. First, "assets with a positive value" can indeed be a problem for a company if that positive value is far less than the value the company has assigned to them on its books. If I have an asset worth $1, but it's listed as being worth $50 on my balance sheet, that's a problem.
Second, the assets at issue here are the mortgages (and mortgage-backed securities), not houses. The house or property is merely the collateral on the loan. A mortgage or a mortgage-backed security is an asset, not a liability. It is, essentially, a right to payment of a certain amount over a certain period of time. The problem is that people are defaulting on their payment obligations (i.e. falling behind on their mortgages), and so the expected money stream is not flowing into the banks. And the collateral on the mortgages (the property) is now worth significantly less than when the mortgages were issued, meaning the owners of the assets generally cannot recoup their money by seizing the collateral (i.e. initiating foreclosure).
The end result of all of this is that these mortgages and mortgage-backed securities (assets) are worth a lot less than the banks thought they were. And because the market for these assets is so illiquid, their actual value is very difficult to determine.
To put it yet another way, banks are holding a lot of assets that no one wants (hence "toxic") and therefore those assets have current market values that are only a fraction of the value the banks have assigned to them on their books. The real question is whether these assets are being undervalued at the moment (because the market is panicked and not functioning properly) or whether their current market value represents their actual value. If the latter, then most of the big banks are almost certainly insolvent. If the former, then conceivably the government could step in and buy all the toxic assets at their "real" value, hold them for a while, and sell them when the housing market stabilizes and a functioning market for mortgages and mortgage-backed securities re-emerges. Even under the latter (very optimistic) scenario, the banks may still be insolvent if the "real" value of the assets (i.e. the price the government is willing to pay) is less than the value assigned to them on the banks' balance sheets.
Whatever the case, though, the problem is that the banks are holding a lot of assets that no one is willing to purchase at anything close to the value the banks have assigned to them on their books.
posted by A.L. at 3:22 PM
9 Comments:
"Whatever the case, though, the problem is that the banks are holding a lot of assets that no one is willing to purchase at anything close to the value the banks have assigned to them on their books."
No, that simply means that they lost money. Matt's point was that the real crisis is that these companies have debt that now exceeds their assets because of what you outlined here.
Well, more accurately they are losing value - they don't lose money until they actual sell the asset. If they sell now they definitely lose money.
On a different tack, I heard an interesting take on this on NPR (sorry, forgot the reference). The talking head pointed out that NOT turning around and lending out the TARP money is the *rational* thing for the banks to do, in their own self-interest. The problem is their balance sheet is clobbered. They need to get as close to the black as possible. If they lend it out, they are not in the black.
This is just like an individual - when you're in debt you hang on to your cash and wait until you're out of debt before buying stocks.
Of course the real situation is WAY more complex/dynamic, and the government could be building terms into the loans that force the banks to lend that money, etc. But I thought it was a valid point.
I think my head is going to explode.
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I think part of the issue with with assets is leveraging. If I borrowed $10 million at 4% to finance the purchase of $10 million in mortgage backed bonds at 5%, then the bank probably has an option to call in my loan if the value of those bonds drops below a certain value, unless I supply additional collateral.
Well, what is the value of those bonds, if no one will buy them?
Here's a really funny question: what's the value of my loan to the bank if no one will buy my bonds? It depends on whatever I can come up with $10 million or not, right? If I can, then the bank can exercise its option, and get its money back. If not, it's worth however much the bank will get in bankruptcy proceedings.
To double your fun, how much is the loan *to* the bank - they borrowed $10 million to lend to me - worth? Same answer - can the bank come up with $10 million? And that answer partly depends on whether I can come up with the ten million, right? Not entirely - the bank has made a lot of loans. But if it's made a lot of loans to people like me, the bank's ability to repay its lenders is based upon our ability to repay the banks, which depends (in part) on the value of the assets we hold.
dammit. my head is going to effing explode. i am going to become a republican so i can do nothing and shout "socialism" at the problem.
FYI: your atom and rss feeds are both broken.
I'm with longhairedweirdo. Is the problem with the original mortgages -- or with all the shenanigans involving derivatives based on those mortgages?
There were bets on the mortgages; then bets on the bets on the mortgages, etc.
Other than at the first level, i.e. the mortgages themselves, it's hard to see why we should be backing anything with government money and/or guarantees
The real question is whether these assets are being undervalued at the moment (because the market is panicked and not functioning properly) or whether their current market value represents their actual value.
The problem is that they can't be valued at all. They don't have a current market value, because there is no market.
This is where the mark-to-market accounting screws everything up. The banks would have much better cash-flow if they could sell some of their mortgage-backed securities and derivatives. That in turn would allow potential creditors to feel relatively confident that the bank could borrow money and pay it back, even if they had to liquidate stuff at depressed values. And if the bank could borrow freely, it could lend freely. Voila! A liquid market.
But mark-to-market means that the moment you sell anything at a fire-sale price, your whole portfolio gets marked down right into the toilet and you're instantly insolvent. Hence the term "toxic asset"--nobody can touch a single one of these stupid things without instantly dying. As a result, the MBS and CDO market is completely illiquid, which means nobody has any idea whether anybody's balance sheet is worth anything... Voila! An illiquid market.
Mark-to-market makes all kinds of sense for a liquid market, but make no mistake: mark-to-market is why the market is illiquid. We all need to indulge ourselves with a little bit of fiction, just for a little while: we need to pretend that the sale of CDO x doesn't affect the valuation of CDO y, even though we know it will, eventually. This is purely a pump-priming measure. Once banks can sell CDOs without being poisoned by the sale, the market will slowly re-liquify. At that point, we'll know what the CDOs are actually worth. Then we can sort the quick from the dead.
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