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Nov. 27th, 2007 11:50 am![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirks"Virgin will pay back £11bn immediately". "Failure to qualify could cost UK economy £1.25bn".
These headlines are thrown around with gay abandon by journalists, non-financial and financial alike. Also, you can guarantee that in any single morning on the Today programme, at least one politician will mention a sum in excess of one billion pounds (they love the sound that the 'b' makes -- it gives the whole thing a sense of importance).
But actually ask them what these numbers mean, and you suddenly get an Emperor's New Clothes syndrome. Because, once you head into the territory of a billion quid-plus, it's like we were seven-year-olds again.
When we were that age, money was thought of in terms of very small purchases -- a packet of crisps, for example. At the age of seven, the "long term" was saving up your pocket money for a month.
"Big" money deals, like new clothes or, say, redecorating, or a holiday, or a new car, involved sums of money quite beyond our comprehension. That our parents had to choose purchase A over purchase B, when the sums involved were for more than a year's pocket money. Well, it just didn't make sense. It was like trying to understand the size of the universe. It was just so big, that you didn't even bother.
That's what these billion-pound-plus sums are to most of us today. We hear the numbers, but we can't equate to it in terms of impact.
So, let's try a bit of this, shall we?
A few months ago Bernanke said that $100bn might make it a systemic event. Today, word on the street is that it might be three times as much. Once again, $300bn, $100bn. Hell, it's just, well, BIG, right?
Let's suppose that $300bn has gone down the tubes. First, one might ask, where the fuck has it gone?
Well, basically, it's gone to give people a few years in a home that they wouldn't have had otherwise. Although the TV programmes feature interviews with Shaquille Templar of southern St Louis (or wherever), with four kids, and threatened with eviction from the home that she bought with a subprime mortgage three years ago, as some kind of tragedy, the sad fact is, she's the winner on the deal. She's had three years in a home that she couldn't have dreamed of living in under proper loan principles. The "value" of that loan in rental terms might be put at $500 a month, or $18,000 in total.
Now, multiply that by 10 million or so, and that's where we get $180bn of it. That money has, quite literally, gone, although it won't cheer up Ms Templar of St Louis, who will now be sent back to wherever she was before this largesse began. Other winners from all this were the salesmen selling these mortgages. They had a few years of good commissions. Their bosses earnt several hundred thousand dollars a year running companies that are now worth jackshit. That money came from investors in subprime securitisations. That money is gone. Maybe all of that adds another $20bn.
In other places, the whole system was a scam. Borrowers didn't exist, houses didn't exist. The money was channelled into the pockets of bent salesmen, bent lawyers, bent appraisers, bent lenders. That funded a nice standard of living for these people. Although some of them may end up in jail, that money is gone. They've spent it.
OK, so, a big number has gone. But what does it mean?
Well, if we take it that $300bn has been spent in the past few years which other people thought was safely invested (but wasn't), then those people have lost their investment. This is where we get companies mentioning "hits" of $600m, $1.2bn, and so on. That money will come from a variety of places. Where the companies are listed, then the investors will lose out. If those investors are pension funds, then the ultimate owners, the final pension schemes, will lose out. Generally speaking, the more savings that you have in volatile products, the more you will lose out.
Let's divide that $300bn by every adult in the developed world. That brings us to about $2,000 a head. That's a nice start point. If you are average, you are probably $2,000 worse off today than you thought you were.
Wow, I can imagine the fun that the Daily Mail would have with that.
But, in the grand scheme of things, it's no big deal. Because we are like kids when it comes to things like this, most adults think of that £1,000 as "extra" -- money that appears and disappears out of discretionary income. But discretionary income is, for most people, only a small part of their overall finances. Add in mortgage payments, savings for retirement, monthly income in and out for a typical household of 1.3 adults (or whatever) and you get a different picture. That grand is less than half the turnover of the household. If a household has a reasonable return on equity (savings that go into pension funds, paying off the mortgage, etc) then it's probably little more than a single month's household "profit". And that money won't come out of discretionary spending. It will come out of 'profit' over the lifetime of the company -- in the case of an earning household, at least 30 years.
In other words, the average household will have to take a profit markdown of 10% this year.
Now, in one sense, that isn't bad. But, in another sense, if the papers said that all listed companies would see their profits impacted by 10% this year, you'd get a fairly serious hit on market prices. And, as with the "average" household, the impact will not be equally distributed.
Looking at these numbers, they feel about right to me. About a 10% hit on the year to your personal RoE, and about a 10% average hit to annual profits for companies. In both cases, there will be a wide spread that will be distinctly Non Bell-Curve shaped in terms of distribution.
So, what does that mean. Well, we know you've lost a grand. We know that this will not directly impact your pocket. We know that there will be losers and non-losers (and a very few winners). And we know that the money has gone and where it's gone. We can live with it. Just call it a single bad downswing in poker terms -- say, for a month. For some companies, with bad bankroll management, it will be goodnight. Others, with better bankroll management, will feel the pain, but will survive. The guys with excellent bankroll management (step forward Warren Buffett) will make lots of money from this.
These headlines are thrown around with gay abandon by journalists, non-financial and financial alike. Also, you can guarantee that in any single morning on the Today programme, at least one politician will mention a sum in excess of one billion pounds (they love the sound that the 'b' makes -- it gives the whole thing a sense of importance).
But actually ask them what these numbers mean, and you suddenly get an Emperor's New Clothes syndrome. Because, once you head into the territory of a billion quid-plus, it's like we were seven-year-olds again.
When we were that age, money was thought of in terms of very small purchases -- a packet of crisps, for example. At the age of seven, the "long term" was saving up your pocket money for a month.
"Big" money deals, like new clothes or, say, redecorating, or a holiday, or a new car, involved sums of money quite beyond our comprehension. That our parents had to choose purchase A over purchase B, when the sums involved were for more than a year's pocket money. Well, it just didn't make sense. It was like trying to understand the size of the universe. It was just so big, that you didn't even bother.
That's what these billion-pound-plus sums are to most of us today. We hear the numbers, but we can't equate to it in terms of impact.
So, let's try a bit of this, shall we?
A few months ago Bernanke said that $100bn might make it a systemic event. Today, word on the street is that it might be three times as much. Once again, $300bn, $100bn. Hell, it's just, well, BIG, right?
Let's suppose that $300bn has gone down the tubes. First, one might ask, where the fuck has it gone?
Well, basically, it's gone to give people a few years in a home that they wouldn't have had otherwise. Although the TV programmes feature interviews with Shaquille Templar of southern St Louis (or wherever), with four kids, and threatened with eviction from the home that she bought with a subprime mortgage three years ago, as some kind of tragedy, the sad fact is, she's the winner on the deal. She's had three years in a home that she couldn't have dreamed of living in under proper loan principles. The "value" of that loan in rental terms might be put at $500 a month, or $18,000 in total.
Now, multiply that by 10 million or so, and that's where we get $180bn of it. That money has, quite literally, gone, although it won't cheer up Ms Templar of St Louis, who will now be sent back to wherever she was before this largesse began. Other winners from all this were the salesmen selling these mortgages. They had a few years of good commissions. Their bosses earnt several hundred thousand dollars a year running companies that are now worth jackshit. That money came from investors in subprime securitisations. That money is gone. Maybe all of that adds another $20bn.
In other places, the whole system was a scam. Borrowers didn't exist, houses didn't exist. The money was channelled into the pockets of bent salesmen, bent lawyers, bent appraisers, bent lenders. That funded a nice standard of living for these people. Although some of them may end up in jail, that money is gone. They've spent it.
OK, so, a big number has gone. But what does it mean?
Well, if we take it that $300bn has been spent in the past few years which other people thought was safely invested (but wasn't), then those people have lost their investment. This is where we get companies mentioning "hits" of $600m, $1.2bn, and so on. That money will come from a variety of places. Where the companies are listed, then the investors will lose out. If those investors are pension funds, then the ultimate owners, the final pension schemes, will lose out. Generally speaking, the more savings that you have in volatile products, the more you will lose out.
Let's divide that $300bn by every adult in the developed world. That brings us to about $2,000 a head. That's a nice start point. If you are average, you are probably $2,000 worse off today than you thought you were.
Wow, I can imagine the fun that the Daily Mail would have with that.
But, in the grand scheme of things, it's no big deal. Because we are like kids when it comes to things like this, most adults think of that £1,000 as "extra" -- money that appears and disappears out of discretionary income. But discretionary income is, for most people, only a small part of their overall finances. Add in mortgage payments, savings for retirement, monthly income in and out for a typical household of 1.3 adults (or whatever) and you get a different picture. That grand is less than half the turnover of the household. If a household has a reasonable return on equity (savings that go into pension funds, paying off the mortgage, etc) then it's probably little more than a single month's household "profit". And that money won't come out of discretionary spending. It will come out of 'profit' over the lifetime of the company -- in the case of an earning household, at least 30 years.
In other words, the average household will have to take a profit markdown of 10% this year.
Now, in one sense, that isn't bad. But, in another sense, if the papers said that all listed companies would see their profits impacted by 10% this year, you'd get a fairly serious hit on market prices. And, as with the "average" household, the impact will not be equally distributed.
Looking at these numbers, they feel about right to me. About a 10% hit on the year to your personal RoE, and about a 10% average hit to annual profits for companies. In both cases, there will be a wide spread that will be distinctly Non Bell-Curve shaped in terms of distribution.
So, what does that mean. Well, we know you've lost a grand. We know that this will not directly impact your pocket. We know that there will be losers and non-losers (and a very few winners). And we know that the money has gone and where it's gone. We can live with it. Just call it a single bad downswing in poker terms -- say, for a month. For some companies, with bad bankroll management, it will be goodnight. Others, with better bankroll management, will feel the pain, but will survive. The guys with excellent bankroll management (step forward Warren Buffett) will make lots of money from this.
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no subject
Date: 2007-11-27 07:00 pm (UTC)She seems to know you judging from some of her spoof tube announcements.
Shame the site is down at the moment - http://www.emmaclarke.com
Did you ask for an injunction?
JayBee. xxx
So long, and thanks for all the fish
Date: 2007-11-27 11:48 pm (UTC)I'm kind of sick to my stomach at reading the same old garbage about who did what, or when, or to whom, or why. Quantification, that's the way to go.
This is, frankly, a brilliant skeleton analysis.
Me, I'm used to dealing with billions, because computers have those awkward bit things that tend to imprint scale on your brain. Also, Visa hit the $Trillion turnover mark when I was over there in 1998 or '99. But yes, the scale does indeed take us back to our childhood, and it's nice to have a basic measuring stick.
Which is where I start to disagree with your measuring stick (although not your conclusions), because the multipliers sound right but the fundamentals don't. Ms Templar has probably saved two or three hundred on her balloon mortgage every month for the last three years. That's good for her, but it used to be a forward predictor (now bust). In fact, I would assume that she has paid the going rate (ludicrously cheap) for even rental in St Louis at the time -- because otherwise, how could rentiers keep up? -- and that she is now, as you say, back to square one. (Albeit with a lousy credit rating. Well, we're all going to be there.)
I see the losses at the back end. Reposession of the assets, and you have to remember that they are real physical assets, requires a write-down, requires maintenance, and requires holding a notional $150K trailer for a potentially unlimited time in the full knowledge that said trailer is worth only $125K at the moment and that the market favours buyers.
This appears to me to be the basic downside of the sub-prime thing. These loons have already put the money out there; they've already committed to short-term financing at the going rate; they do, indeed, have assets, but these assets are the kind of assets that they were hoping that some other idiot (aka thousands of Shanilles) would cover.
As you say, this spells good news for Warren Buffett; and anybody else out there with no immediate problems and a decent cash-flow.
But that was, honestly, a post of genius.
Even though I don't understand why I suddenly owe some sort of amortised $1000 a year.
no subject
Date: 2007-11-29 12:31 pm (UTC)Very good and intersting post - the cost is burdened as some lack of growth.
I have just one comment and one question. You mention the figures feel about right, yet I would have thought the average cost for the anyone in the uk would have been greater than any global average figure arrived at.
The question - could you expand on the loss $18k generated on the defaulters? The way I'd seen it, these subprimers are paying interest on the loan, so the loan is earning money, until they default at which point the creditors no longer have a debt but a home. I would have thought the transparent losses incurred are simply the defaults on payments and any negative growth on the property (which may not exist). I'm obviously missing something.
Thanks
fiscally naive
no subject
Date: 2007-11-29 01:09 pm (UTC)I say that we divide the number by "every adult in the developed world", which basically assumes that the impact on the emerging economies' 'aberage adult' approximates to nil.
The "loss" of $18k is a bit more nebulous and aardvark touches on this very point.
In effect, the loss is the difference in the current value of the repossessed home from the previously assigned value in the collateralised debt obligation. So you could say that the "winner" was not so much the person who lived in the home, as the housebuilder who sold it. In a sense I was assigning a 'value' to the improved quality of life of the subprime borrower over those periods.
However, it's not as clear-cut as that and, of necessity, I simplified. Some residents gained enormously from an improved quality of life over these years on subsdised loans (most of these loans were heavily discounted over the first two or three years of the loan, but were 'valued' over the full term of the loan in the CDO -- therefore the resident was effectively subsidised for years one and two and was expected to pay back that subsidy over years three to 20). However, others were persuaded by slimy salesmen to switch mortgages when it was not in their interests so to do.
So, to answer your question, part of the "value" to the subprime borrowers was in the form of an improved quality of life (they were living in a home of a quality far better than they would have been renting) and part was in the form of a subsidised mortgage (they were paying a rate lower than the average for the full term of the loan, but that loan was valued as if the loan would be repaid over the full term, rather than defaulted).
By defaulting, the value disappears in two ways. The first is that the CDO now consists of a lot of illiquid assets rather than a steady income stream of interest payments. The second is that the illiquid asset is not worth the value of the loan.
As Pete pointed out, this can be amortised out, eventually. This is why part of the problem is one of liquidity and we are seeing a credit crunch. Those houses, so long as they weren't part of a complex scam, exist, and will eventually have a value rather higher than they have if they were sold tomorrow. As with LTCM, time can be a great healer, and it is this line which the "cash injectors" at the Fed and at Freddie Mac will push.
Sorry, that wasn't a particularly simple or cogent explanation, but it IS a complex area...
PJ
no subject
Date: 2007-11-29 01:45 pm (UTC)The loss through subsidisation makes sense. And likewise that builders are the ones gaining through the markets desire to get these packages out there. It seems a bit like the dot-com bubble - get a float, no matter, cause we'll be able to sell it on for more. In this case just get the loan out in the market, cause we'll be able to sell it on, move it about. So I guess they make the entry so damn easy for anyone, just so they can get a tradeable product/commodity (?) out there. As such money becomes cheap and builders build better over-valued homes. This is in part the concern, I'm guessing this wasn't how it was back in 1990 - that mortgages weren't so liquid and tradeable; so although the interest rates are no where near as high, crash conditions might exist in a much less consipcuous way.
I would have thought many of these houses are still worth more than the initial loan agreements, but I'm not familair with how bad things are over there. I was amazed to find that many new-builds in say Leeds are worth 50k less than was paid 5 years ago. As for the sub-primers, they may have gained some value I guess in getting a better quality of life than had they paid rental equivalent; but I suppose they become even more sub-prime now and will be fighting for a smaller share of the sub-prime market share. So tough times.
Incidentally, I noticed on some gambling forum, some guy stating that one of the spread firms had house prices less than the current value for 2010. Do you subscribe to this? I heard one analyst a couple of months back desrcribing commenting on rising personal debt, credit crunch, higher interest rates as a conditions for a perfect storm. Gulp.
cheers
f.n.
no subject
Date: 2007-11-29 01:52 pm (UTC)25% chance of plus 5%
60% chance of minus 5%
15% chance of minus 30%
and you get a total weighted average spread spot of minus 7.5% or thereabouts.
PJ
no subject
Date: 2007-11-29 04:05 pm (UTC)