maybe this is a dumb question but....
- the current credit crisis was put in motion by the housing bubble burst
- the housing bubble burst, people started foreclosing on their homes
- people foreclose on their $750k mortgage, house is not longer worth 750k so while the bank expected to salvage 600k, they are now salvaging 450k
- banks lose money on loans, lend less/want higher interest rate
- people can buy less houses
- housing prices continue to fall
- people continue to foreclose on homes
- foreclosure value of homes fall more
- banks lose more money
is this 'ball-park' accurate? And the real question Im asking is, the money went somewhere. Where is it? The bank lent 750k, Joe Schmoe paid 750k for his house. Where is that 750k? Who did that money go to? Where is it now?
It went to the people that sold the house, or it went to the people that sold the property and the construction company that built the home.
One overly simplistic way to look at the outcome:
Seller: gained $750k less the original home's purchase price Buyer: lost any equity in the home (likely only the Buyer's down payment) Bank: lost $300k ($750k - $450k), offset somewhat by the amount of Buyer's equity
I meant in the aggregate economy, not in that one example.
In the aggregate economy, this incremental value is effectively gone.
Most sellers turned around and became buyers, using the inflated prices received for their old homes to purchase new homes at inflated prices. Increased home prices were nothing more than froth in an excessively liquid, fast-and-loose credit enviroment. Now that lenders have sobered up, this froth is (for the most part) gone.
The 'money' has basically disappeared because it wasn't there in the first place.
If the true value of a home is 450K and it was selling for 750K based on the market at the time it was sold, then that 300K differential was an overestimation of total demand (going into the future) and true current value. Thus, if the value of the nation's housing stock declines from 10 trillion to 8 trillion based on demand and assessed asset values (grounded in what individuals are collectively willing to pay for housing assets), then that 2 trillion has effectively disappeared in the aggregate economy.
On the micro-level, there was a transfer of wealth from buyers who bought inflated assets to sellers who sold assets at prices higher than their (current) "true value" (provided the sellers didn't go ahead and purchase other houses).
The size and direction (rich to poor or vice-versa) of this transfer is unknown. If wealth inequality rises (a very noisy variable), we can possibly ascertain that shift (of course, we would need to control for a variety of other factors).
put pretty simply, all these bank write-downs you are seeing - that's where the money "went"
money doesn't disappear. sorry. home prices values are an input, not an end result. only the mortgages matter.
in the end, it all comes down to cash flow. all these mortgages were either sold-off or kept on BS at a price valued vs. assumed cash flows. most were sold into RMBS structures which were then diced into CDOs, some into CDO squareds. Many of the latter two have stopped paying ANY cash flow long ago, and these assets are only worth some financially engireered foreclosure value amalgamation. Equity tranches are zero.
The reason they are lending less and demanding higher rates is that now there's no secondary market for non-agency mortgages. If you make one, you're going to keep it on balance-sheet, and you better as hell be sure that is high FICO, low LTV, prime as prime can be. Not many of those left, and most are smart enough not to want to "catch a falling knife." Prices fall more, ARMs and especially option-ARMS reset, more write-downs. It's ugly.
Maybe this is a dumb question but why would lower housing prices be a driver for increased foreclosures? Seems to me that mortgage holders would pay their mortgages out of their monthly cash flows, don't see how lower house prices would have such a strong impact on that.
Contrary to the picture painted by mainstream media, financial hardship / other income-limiting factors don't drive foreclosures nearly to the extent that falling home prices do.
History has shown that when the value of one's home equity drops below zero, many people choose simply to cut their losses and walk away.
I see- makes sense on the macro level. I was thinking on a personal level, if that happened to me, I would probably choose to keep the house in the expectation that in the long run it would turn positive. Once you factor in transactions costs, etc. it would make more sense to just stay put but I see the point.
This is why you will never have the pleasure of being a sub-prime borrower.
You're also forgetting that many people took out gigantic loans for homes that were too big for their yearly income on the premise that they could refi in a few years (and also assuming their houses appreciate, they get promoted and make more money, etc.), or maybe they just straight up lied about their income (they're called "liars loans" for a reason). Sometimes these loans would be interest only for 3 to 5 years then they figured they'd either sell or refi. Well, when your house deteriorates 50% of it's value, nobody will refi for anywhere near the same amount (especially now that the market has blown up) and definitely not for the same rates you got before when banks were underwriting these loans, assembly-line style. That's when the banks foreclose on your home.
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