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Thursday, December 6, 2007

The ABC's of bailout math

Here's why you needed a bailout on housing, and why home prices must go up. The bears realized this, and bet it would happen. But they bet wrong. Consider these facts: (It's back of the envelope, but I prefer to keep things simple.)

Housing "equity" was reported to be at a record low of 50.4%, which is home prices minus mortgage debt. Bulls will tell you that housing equity grew from $7.1 to $10.6 trillion the last 5 years. But equity is only at 50.4%. Why is that so alarming?

Approximately 1/3 of all homes are owned outright. So of the $10.6 trillion of equity, let's take 1/3 of it off. Since equity is at 50%, the value of homes is $21.2 trillion. 1/3 of homes are owned with no mortgages. So take $7 trillion off of $21.2 trillion, (.33X21.2 trillion=$7 T) and you have $14.2 trillion of homes with mortgages. Government figures say we had $10.6 trillion of equity, but $7 trillion is by those who own their homes. Subtract $7 trillion from $10.6 trillion, and you have $3.6 trillion as the equity component on $14.2 trillion, the value of homes with mortgages on it. $3.6/$14.2=25% equity in homes with mortgages. Now that is sobering!

That's why, the financials were so darn weak. Bears looked at the figures and bet their billions the system would be insolvent. Or at least they hoped it would, as they could then proclaim they were the masters of the universe. But if you buy some time, which this plan will, you'll be able to coax the previous homeowners, who are now renters, to get back and buy, while keeping inventory off of the market to stabilize prices. And you need lower rates, to incentivize buyers. And you'll get them.

Builder's can't sell homes when they are competing with short sales and foreclosures. The public homebuyer, is as unrealistic in pricing homes now, as the financial players were two weeks ago, when they should of been covering their shorts with both hands.

But greed and spreadsheets got the best of them. Remember all those writedowns on securities? Those prices are now going up! Why do you think the brokerage firms and investment banks wanted people to sell? So they could scoop up this inventory at cheap prices.
And now, the market, slowly but surely, is delivering it's putative punishment to those who hold to their wayward viewpoints. It's the same in housing. Don't you want to buy a house at a distress sale? Of course you do. But how is it possible for everyone at the same time to buy a house at a distressed prices? If they could, you wouldn't have bragging rights. But that's what Wall Street wanted you to believe.

Now lets do some more math. What's the figure that gives those who own mortgages on homes a 40% equity position? We start with $3.6 trillion equity, so add $3.6 on it. Now you have $7.2 trillion equity on on $17.8 trillion, (14.2+3.6=17.8) or a 40% equity rate. (7.2/17.8=40.44%). The appreciation of homes then is 25%. ($3.6/$14.2 =25%.)

At that number, will there be any bailout? Of course not, because then it is economical for the bank to own your home. The bailout plan is for five years, so they hope housing appreciates at a 4.0456789% annual rate the next five years! It's as simple as 123, which are the only figures missing.

But maybe that was just the ABC's.

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