Monday, March 23, 2009

Just How Bad IS the "Toxic Asset" Problem?

Less awful than most people think.

Kevin Drum:

...if markets can overvalue assets on the way up — and obviously they can — then they can also undervalue them on the way down. There's a pretty good chance that the toxic waste in question really is worth more than the market is currently willing to pay for it.

He also makes a point which I've made now and then:

...because of a lazy shorthand that a lot of us have fallen into: namely the notion that the value of mortgage-backed securities is certain to keep plummeting because home prices themselves still have another 20-30% to fall. But these securities aren't backed by the value of the homes they represent. They're backed by mortgage payments. Home prices could fall by half, but the value of the securities wouldn't drop by a dime if homeowners kept making their monthly payments. Their value only drops if default rates go up.

Defaults are running at 4.5%, approximately triple the last 20-year average of 1.7%. That can be expected to continue for a while, but not forever (with the usual caveats).

But is this substantial enough to write down ALL mortgage-backed securities?

Nope.

All of which means that it is possible Geithner's plan will work.

Observes JustOneMinute:

The FDIC IRR is at best 2%, when the loan is repaid in full. The Equity IRR is never less than 12.5% (as explained earlier) but can rise if the toxic asset holds its value or appreciates. Finally, We the People experience the "Taxpayer IRR" which is calculated after summing the FDIC cash flows and 80% of the equity flows.

(That is followed by a chart which shows a net positive to the Taxpayer except if the asset-packages deteriorate to less than 40% of CURRENT value. The assumption is that those packages would be purchased at 50% of CURRENT value.)

It actually could work--but there's one more very important component: unemployment must be contained or reduced, and relatively fast.

3 comments:

J. Strupp said...

Ha. So we should enter into a private/public partnership, with FDIC bearing the brunt of the downside risk, based on the hope that all of these toxic assets are PROBABLY undervalued? I hate to break it to you DAD, but there's a very good possibility that these assets are much closer to zero than you think. I fear that this PIP scheme is only going to drag out the inevitable at the expensive of the taxpayer......again.

I'm not buying it.

Dad29 said...

OK. Don't.

J. Strupp said...

Don't really have much of a choice at this point it appears.