Note: We had hoped to deliver a FDIC Bank Closure Report today, but no banks were closed since last Friday.
We have been hammering on the shocking lack of home equity that most owners with mortgages in the USA actually have. This short article explains the situation mostly very well (and has a nifty chart to boot), but overlooks one critical point: about one-third of homeowners own their homes free-and-clear, that is, having no mortgage. We will explain why this is so important.
First, a brief quote from the article (bold added):
"When value falls and debt stays the same, equity gets crushed (See The Problem With Debt). If house prices end up falling more than 40% peak to trough, which seems likely, U.S. homeowner equity will drop more than 70% and as many as half of American mortgage holders will be underwater."
This is not correct. If homeowner equity drops more than 70%, virtually every mortgage holder will be underwater. Using figures from the article, at present the value of all houses is about $18 trillion and the amount of mortgages is $11 trillion, which leaves $7 trillion of equity. If you take into account that about one-third of homeowners do not have a mortgage, this means that about $6 trillion of houses is owned free and clear, and $11 trillion of mortgages is on $12 trillion of houses.
All that it would take to put the group of homeowners with a mortgage under water is just another drop of $1 trillion, or a little over 5% of the current value. Of course some would be very underwater, and some not at all, but the overall situation is quite precarious. This is very bad for the homeowners who can't sell if they want to, and can't refinance because there isn't enough equity.
It is even worse for the banks, and the Federal Government. Once that 5% additional drop happens, even prime mortgage portfolios are truly junk investments since the collateral no longer covers the principal amounts. A peak to trough 40% devaluation as suggested by the quoted article will bring many trillions in losses to the Federal Government, and ultimately the taxpayer. Underwater homeowners - either unable to make mortgage payments, or having little incentive to do so even if they can afford them - will 'walk away' en masse.
Showing posts with label taxpayer. Show all posts
Showing posts with label taxpayer. Show all posts
Sunday, May 17, 2009
Monday, March 30, 2009
Bring Back Bank Branch Laws
In the present popular discourse, a great deal is said about how to clean up the financial mess, but not much about how to prevent a future financial catastrophe. Vague calls of "more regulation" fill the air, but not many concrete proposals can be found.
Our very concrete proposal is to return banking to a fragmented industry where the preponderance of financial assets are held by tens of thousands of institutions instead of a few global behemoths.
In the past, fragmentation was enforced not by heavy-handed regulation, but by a simple principle of law: a bank could have only a few branches, or even in the most restrictive jurisdictions, just one.
For example, from 1870 to 1967 in the State of Illinois, banks were not allowed to have even one branch in addition to its home office. In 1967, banks were allowed to open a separate drive-through building, so long as it was withing 1500 feet of the main office! Gradually the law was liberalised, and by 1993 Illinois banks could open an unlimited number of in-state branches.
In 1994, the US allowed interstate branch banking for the first time, and since then banks have expanded and consolidated across state lines. As a result of this 'reform', there has been an enormous concentration of banking assets in the hands of the nations largest institutions.
Interestingly most of the problem assets currently involved in 'rescue' schemes are held by these largest institutions. In other words, these super-huge banks that have grown up over the past few decades have made terrible investment decisions, blown their capital, and are now giant purse-sucks on the US taxpayer.
The whole housing bubble fiasco and consequent Depression might have been avoided if the Branch Banking Laws had not been 'liberalised'. It is true that a fragmented banking industry is more expensive in theory, but in practice the de-fragmented industry has turned out to be vastly more expensive.
Our very concrete proposal is to return banking to a fragmented industry where the preponderance of financial assets are held by tens of thousands of institutions instead of a few global behemoths.
In the past, fragmentation was enforced not by heavy-handed regulation, but by a simple principle of law: a bank could have only a few branches, or even in the most restrictive jurisdictions, just one.
For example, from 1870 to 1967 in the State of Illinois, banks were not allowed to have even one branch in addition to its home office. In 1967, banks were allowed to open a separate drive-through building, so long as it was withing 1500 feet of the main office! Gradually the law was liberalised, and by 1993 Illinois banks could open an unlimited number of in-state branches.
In 1994, the US allowed interstate branch banking for the first time, and since then banks have expanded and consolidated across state lines. As a result of this 'reform', there has been an enormous concentration of banking assets in the hands of the nations largest institutions.
Interestingly most of the problem assets currently involved in 'rescue' schemes are held by these largest institutions. In other words, these super-huge banks that have grown up over the past few decades have made terrible investment decisions, blown their capital, and are now giant purse-sucks on the US taxpayer.
The whole housing bubble fiasco and consequent Depression might have been avoided if the Branch Banking Laws had not been 'liberalised'. It is true that a fragmented banking industry is more expensive in theory, but in practice the de-fragmented industry has turned out to be vastly more expensive.
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