What’s a Bad Bank?
Have you wondered what this bad bank thing is that Obama is looking at? Let’s take a look at this letter from First Fictitious Bank that will help us understand what a bad bank is and how it works:
“I have an embarrassing question to ask you. It’s not something that I’m proud of but I need help. I own a bank. When I noticed that the housing market was going up fast, I invested in something called Mortgage Back Securities. You may not know what these are so let me explain. An MBS is similar to a bond where people make money off of the money that people are paying on their mortgages. As long as people are paying, I’m making money.
Here is the problem. I didn’t think that the real estate market was going to plummet. I didn’t expect that so many people were going to foreclose on their homes and I didn’t expect that companies like Fannie Mae and Freddie Mac would largely cease to exist. Now, my MBS assets are worth a fraction of what they were. What’s worse is that I invested too heavily in them and although officially my Mortgage Backed Securities are still worth $100 billion, they are probably only worth about $60 billion and maybe less. Nobody will but them from me.
The good news is that I still have another $100 billion in good assets. These are loans that people are paying and they are making my bank money. I have $180 billion in liabilities. This is the money that people have deposited in my bank that I have to pay them if they make withdrawals. People are seeing these MBSs on my balance sheet and don’t want to invest in my bank because they think that once I sell them, my bank is going to have more liabilities than asses and we won’t be solvent.
We wouldn’t be able to pay back those that have deposited money with us. For that reason, investors won’t buy our stock. If they won’t buy our stock, we can’t lend to other banks, small businesses, or to you. It stems from these Mortgage Backed Securities that are bringing my bank to a standstill. If you can think of anything I can to get these off of my balance sheet without taking a huge loss, I would be most grateful. I have heard of something called the bad bank idea?”
This is the real world scenario that many banks are facing. If you understand the above account, you under the basics of why the banks are largely holding our economy back from recovery. If they can’t lend to others, the economy grinds to a halt. The government is looking at creating what is being called a “bad bank.” This bad bank would buy up all of those bad assets from the banks leaving a much cleaner looking balance sheet which would hopefully entice investors to again invest money in these banks which would entice banks to get back to healthy lending. Economists believe that this would be a powerful catalyst to economic recovery.
If you’re wondering how investing mistakes can simply disappear from the banks’ balance sheet, you aren’t alone. It is believed that it may take more than $1 Trillion to buy these assets. Additionally, many argue that if any company makes bad financial decisions, they should pay the price and if that means going out of business, so be it.
That debate hasn’t been solved as of yet but many argue that if these banks fail, so does our financial system and until they are able to lend again and people will invest in them, the economy will continue to get worse.
You now understand the most basic premise behind the bad bank idea. What do you think? Is the bad bank idea a good idea? Let us know.
The 2 Ton Elephant in the Room
There is much wisdom in the cliche.”You only see what you know”. Everyone is ignoring the “2 Ton Elephant in the Room”. Many agree that the contributing factor to most of our problems is the consumer’s lack of financial understanding. He is like a “Boat without a Paddle” when it comes to managing money and making money choices. It can be argued that this was the primary cause of the Subprime Mortgage Crisis which precipitated the Credit Crunch and our current economic woes.
We have tried foreclosure moratoriums, loan modifications, bailouts, in the belief that these initiatives will save the Borrowers. The fact is that these measures have failed and are not working! These measures are only postponing the inevitable defaults. The evidence is that Re-default is occurring anyway at a rate of 60% within 6-8 months.
Let’s finally address the real issue which requires developing a program of “Immediate and Specific Financial Guidance” to help the Borrower understand how to manage his financial affairs. This can and must be done, or we can expect to repeat these errors again and again. We need a more Financially Literate public in order to survive in this complex economic environment. It should be clear by now, that we are all in the same boat together. Our economy seems to be impacted by our individual financial decisions.
BAD BANK
Under the “Bad Bank” scenario, the taxpayers will own these Troubled Assets which are comprised of “Toxic” mortgages.
In effect, the US government (taxpayers) will be bearing the loss on these “toxic” mortgages. The growing concern is that these losses will continue to materialize as defaults increase with the projected 8 million foreclosures expected over the next four years. It seems that the key to this crisis IS THE BORROWER!
The underlying “troubled assets” are the “toxic” mortgages such as Alt-A, Option ARMs, Interest-Only, etc. that are interwoven into the Mortgage Backed Securities, Collateral Debt Obligations, and other derivative investments that are leveraged into investments valued in the trillions of dollars worldwide.
Since the valuation of these “toxic” assets depends on the Borrower’s ability to make the monthly mortgage payments, the key to a solution of this Economic Crisis is the Borrower!
Everyone is betting that the Borrower will default and foreclosures will follow. The high rate of foreclosure should have been expected because the Borrower has no concept of managing money and is like a “Boat without a Paddle”.
The Borrower is in desperate need of “Financial Guidance” in this complex economic environment that requires “informed” financial decision-making. The Subprime Mortgage Crisis, out-of-control consumer spending and credit card usage, and the spike in foreclosures and bankruptcies provide evidence of that fact. Loan modification or “Bailout” will not work. Even after loan modification, the re-default rate was 60% within 6 months!
The solution is a program of Immediate and Specific Financial Guidance that will help the Borrower “naturally” be able to make the monthly mortgage payment, without “bailout” or extensive loan modifications which have proven to be a failure. This program is NOT the so-called Financial Literacy initiative that simply disseminates “information”, but rather it is a program that will help the Borrower “understand” how to manage money and avoid the pitfalls that have previously caused financial
distress.
Borrowers, both small business and individual, require Immediate and Specific Financial Guidance in order to avoid default and foreclosure. As the Borrower is successfully guided to avoid default, the financial and housing markets will respond favorably. The result will be a reversal of the downward trend in the valuation of the “troubled assets”.
If we are successful, we can turn this crisis “all around” and stimulate the economy “naturally” rather than by “bailout” which does not guarantee success.
Instead of the expected losses, the US government (taxpayers) will benefit from the unexpected gains that will result as these investments grow in value.
Samuel D. Bornstein
Professor of Accounting & Taxation
Kean University, School of Business, Union, NJ
Tel: (732) 493 – 4799
Email: bornsteinsong@aol.com
There are some really huge liabilities involved here.
Who pays for them? Duh…I submit the folks who made them.
Anything else is sure to a provoke a response from those the politicians (and other clueless people) think they can neatly offload the problem to.
You broke it, you pay for it.
This is directed to Wall Street, Congress and Greedy Home owners .
I’m a retired broker and I have been screaming the words “financial education” at my friends, family and clients for years.
Sadly I may as well been talking in ‘martian’ to most of them. I do believe that our governments have a slice of the blame here. They could easily educate the masses to look for the deal that is best for them.
But I tend to think that up ’til now the world governments have purposfully avoided this as the fat cats need to be fed from somewhere. I sincerely hope this current turmoil will kickstart people to educate themselves better.
I deal with banks on a regular basis in my San Diego real estate business. I think it’s safe to say that most banks are ‘bad banks.’ They simply don’t train their employees well enough to handle their jobs. They understaff, undertrain, and hire underqualified people for important positions.
Banks used to be synonymous with conservatism and good management, now they are more about greed, high risk, and high margins. The corporate culture that led to the mortgage meltdown has not gone away. The sad thing is that when the government gave the banks all of the taxpayer bailout money, the administration actually thought that the banks would clean up their acts and fly straight. It simply hasn’t happened. Instead the banks pocketed the money and are still up to no good.
Geoff@San Diego Real Estate´s last blog ..MIA San Diego Foreclosure Properties
Personally i think the banks lost the plot in the early 90′s and never really recovered. This latest crisis will probably be a good thing and get them back on track.
mark@Credit Card Debt Forgiveness´s last blog ..Credit Card Debt Forgiveness
Yes, you can pound the question good bank or bad bank. But it all boils down to education. The last 50 years the public education went down terribly the drain. Our people do not comprehend much! High school graduates can hardly read or write or do simple math. We need to educate again and then the people can understand again.
The Bank now days is as important as the banker. When WAMU was bought out by Chase and they start playing the old switch-a-roo without notification of changes. Your good old banker could do nothing for you.
Although we have seen some foreclosures in Ottawa they are mostly those of homes and condos but rarely do we see multifamily ones. My investors would be very happy with if that was the case.