Newsletter – November / December 2008 – Stop the Bubble Machine


Stop the Bubble Machine

Okay, you’re an investor. The family next door bought their house for $400,000 a few years ago with no down payment and a 40-year amortization. Now the house is worth $360,000 and the owner has been laid off. They can’t make the payments. The bank is foreclosing.

You could go to the bank and buy that mortgage. You know the family and you know the value of real estate in that neighbourhood. Let’s say you bid 60 cents on the dollar for that mortgage: you offer to buy the $400,000 mortgage debt from the bank for $240,000. The bank might consider it and you might make a deal. Both you and the bank understand the risk and can make a deal at some price. That’s NOT the problem in the US subprime mortgage mess.

The problem is that some slick broker put millions of these mortgages together creating “mortgage-backed paper.” Then they sold the paper to naive banks all over the world. And now those banks are trying to sell that paper. But who will buy? All the banks are aware of the U.S. mortgage situation are trying to sell. Problem is there are no banks who want to buy. Noone will bid 60 cents on the dollar. No-one knows home prices in the neighbourhoods and no-one knows the family who is struggling to make the payments on their dream home. And the only ones with enough cash to bid on multi-billion dollars of mortgaged- backed paper are the big banks who are trying to sell! And there’s no bid.

So what’s the paper worth? Zero? I’m afraid so.

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