Thank you for your replies.

Again, I want to emphasize that phrases like “no buyer” and “zero” are rhetorically powerful but deceptive.

Perhaps you can correct me: As I understand what is going on, banks and other regulated financial institutions need to establish their solvency and safety to the government. This is done through the federally-requied “mark to market” accounting. The problem is that beacuse fo their previous investment sources, banks now find themselves holding MBSs that, if they would wish to sell, would have to be sold at a substantial discount.

The same is true of course, for oil, stocks, mortgages themselves, and many other financial instruments.

These financial institutiosn do not believe it is fair that the same accounting rule that would price oil pruchased for $140 at $40, and a NYSE index find purchase at 14,000 at 7,000, and a house purchased at $2,000,000 at $1,000,000, would price an MBS at a heavy discount as well.

If these financial institutions would attempt to sell, they have two choices

a) they can sale them for the value they priced at, in which case there would be no buyers
b) they can sell them at some moderate discount, in which case only the most speculatiev and risk-friendly investors would occasionally buy them (a relatively less liquid market)
c) they can sell them at some heavy discount, at which time the market becomes relatively liquid as many purchasers step up to buy them

Again, as I understand, mark-to-market is allowing these financial institutions to use (b), the middle ground, where MBSs are not marked at face value, but marked far above a value which would bring a large number of buyers to the market. Of course, as a consequence of the upper-end estimates that apparently are allowed by mark-to-market, the market is relatively less liquid. (In the same way, a gas station at the interstate which sells gas at $3/gal will have far fewer customers — essentially, a less liquid market for gas — than one that sells gas at $2/gal).

http://www.census.gov/hhes/www/housing/census/historic/values.html

I myself would not mind seeing that unravel, but not in one fell swoop. There is no rational reason for housing and land to be so expensive. In the future people will need that money for energy, which is about to go through the roof. Something is going to have to get cheaper, and it’s likely to be housing.

Consider common stocks, which are heavily traded. Mark to market means exactly what it says. In a heavily traded instrument, like a common stock, the sellers asks a price. The buyers make a bid. If the seller stays firm, the buyers make an unconscious group decision, they either go up to the ask, or stay with their bid. If the sellers detects the buyers are not moving up, the sellers make a group decision – usually to lower their price, and the buyers have their quest. 100 sold at 2 instead of 2.1. That process will ratchet up and down all day based upon all sorts of external and internal stimuli – news and rumor. That is mark to market on a by second basis.

What happens when there are no buyers because they have no credit, and are scared to death of using their own cash? Would the seller of common stock tick down his price until 4pm, and resume ticking it down until 4pm of the next day – on and on? Or would trading rules rush in and end the insanity by suspending the mark to market activity until rationality returned? Are we going to let some kid in Sioux Falls break his piggy bank and buy the entirety of Apple for .000000001 cents a share?

What Bove appears to be saying, and he is inside these banks quite often, is that they have MBSs priced far below the present value of their performing loans. That is irrational. In a normal market, that price would get the MBSs sucked off the table. Mark to market cannot work in an irrational market. Insisting markets are rational when they clearly are not is irrational human behavior.

As for the actual discount, I don’t know it. The media uses “marked to zero.” That probably is an exaggeration.

Thank you for your comment. I will try to address it soon.

sonofsamphm1c,

You did not address my point, but merely restated facts with which I agree.

What I called “hyperbole” was your assertion that performing AAA MBSes are worth $0, with no buyers. I offered an alternative explanation that they had fallen significantly in market price, say 40%-60%, and that no buyers could be found at the price that Citi et al. would prefer. Could you clarify this?

“Some analysts, including Rochdale’s Bove, argue Citigroup is solvent, and a victim of accounting rules that place too much emphasis on the current market value of assets. Because no one wants to buy soured mortgage-related assets that banks including Citi hold, their values have plunged — although the loans underlying many of them are being paid. …” – Richard Bove is an experienced financial analyst

“Accounting rules require the banks to mark almost all such assets to market-adjust their value according to prices brought by comparable securities in recent sales. But the markets for many of these assets are frozen, making it difficult or impossible to value them accurately. …”

http://money.cnn.com/2009/02/27/news/economy/tully_banks.fortune/?postversion=2009022707

Oddly enough, this statement works well with Sam’s statement about population flows. How much housing of a price supportable by the market can be introduced by renovating or rebuilding housing in the inner cities, the areas those middle class people are gradually migrating towards?

I wouldn’t say that the surplus of outer suburban and exurban housing is only because of the price, though. In many cases, you have housing that was built below standards or at least on the cheap. In some cases, it was the sites that were substandard, with subsoils that couldn’t support what was built on top of them for long (a big issue here along the Front Range) or a risk of wild fire or flood that was addressed only with insurance and hope of FEMA funds. Even if the prices fall for that housing, who is going to live in them aside from ghetto dwellers who can’t find better housing or rich morons who cost society more than they contribute?

Which gets back to the issue where I left off in my last comment–the people living in the areas built up during the boom. What fate is best for them and for society?
Negative equity in an underpopulated neighborhood might be at least partially eliminated by turning large contiguous blocks of vacant housing into parkland, wilderness area or (if otherwise absent) other community or commercial services. At least, that’s the case in large parts of Colorado where recreational areas and natural beauty are frequent selling points.
But what if it isn’t? If a nearby park or school or whatever built nearby isn’t enough to raise prices back to parity, you seem to have 3 ways to view the situation:
1. Assume that equity is the be-all, end-all of long-term financial security, like I did and many others do. If you can’t deconstruct and reorganize an area back to neutral or positive equity, what other options exist besides physically removing the remaining occupants to an area where they can have that good equity?
2. Assume there are many ways to address future insecurity besides equity correction. Socialized health care is one. What others exist that denizens of this blog can live with?
3. Assume there is little that can be done. Limit intervention to deconstruction of sub-standard housing- or doing nothing- and wish residents well.

What methods of equity regeneration, viewpoints and/or options have I missed? Where do your preferences lie?

Thanks for your comment.

Sellers are one half the market, and they have every right to strategize and employ tactics (legal) to enhance their position. You want them self lobotomize.

I agree with the first sentence, and I don’t understand what you mean by the second.

The value of the mortgage-backed securities is marked to zero because there are no buyers. In the absence of a buyer, the zero valuation is an arbitrary accounting number. It is not economic reality. It’s a complete fiction. Everybody knows a performing loan is worth more than zero.

Are you being serious, or is this hyperbole?

I, for one, would gladly pay $1 for a performing AAA-rated mortgage backed security. I could make back by investment in about a minute!

I will await your clarification, but it strikes me as far mor elikely that the market price for these securities is below what the owners wish to take — say, between 40% and 60% for the bulk. In the same way, people who bought oil with a face value of $140, people who bought a stock index fund at 14,000, people who bought homes with a face value of $200,000, people who had been earning $80,000, each may face a lack of buyers for their products at prices they feel is “fair.”

It is not true in these cases that there are no ”buyers’ — only that there are no buyers at a price they would like.

Now, of course, some stocks are up on the year, others have sunk almost completely. Same with personal incomes, home values, and so on. I’m not saying there is no variation in the price of these assets — just that asserting there are “no” buyers reads like code for “no buyers at a price I prefer.”

If I advertised my vintage guitar for sale, and no buyer emerged in the first two months, does that mean my guitar is worth zero? Claiming that is economically irrational. Now, all the poor guitar players of the world would love to have my lovely 1937 D-18 for zero, but, as the seller, the market does require me to be that dumb.

This is a good example for the difference of zero market value, at zero buyers at a price prefered by sellers. I would wager there are very few guitars sold on ebay, for instance, with a winning bid of $.01. I imagine there are a lot of guitars there that go unsold because of a minimum winning price requirement. The first indicates an absense of buyers. The second represents a hope on the part of seller that the price will rise.

The value of the mortgage-backed securities is marked to zero because there are no buyers. In the absence of a buyer, the zero valuation is an arbitrary accounting number. It is not economic reality. It’s a complete fiction. Everybody knows a performing loan is worth more than zero.

There are no buyers because the free market is frozen with fear, an exceptionally unusual circumstance that rarely ever happens in free markets. They are not marked to zero because they have zero value, and marking them to zero is entirely irrational (accountants love economic irrationality and Lemming behaviors), and it has had an irrational impact on the economy.

If I advertised my vintage guitar for sale, and no buyer emerged in the first two months, does that mean my guitar is worth zero? Claiming that is economically irrational. Now, all the poor guitar players of the world would love to have my lovely 1937 D-18 for zero, but, as the seller, the market does require me to be that dumb.

In a climate gripped with fear, a performing loan is marked to zero, and it is written off against income – income which includes the monthly interest payment for the performing loan that has just been written off to zero. Nuts.

That is an irrational scenario, and, unfortunately for my country, it has happened.

In the case of a bank that refuses to sell a foreclosed house below a certain price, if they believe they will make more money over time on the house than they could on the lower amount of cash the buyer wants to pay at that moment, then it is a rational market tactic to retain possession of the house. Time will prove whether they will be right or wrong.

full disclosure – I seldom watch financial TV.

I would say you want an executive for a secretary’s wage, and I’m saying the executive is worth more – even if he’s in the soup and bread line this year. This year will pass.

Agreed that Michael’s plan is radical.

The housing that Michael wants to destroy is ‘surplus’ only because the price the seller wants is higher than the price the market can support. The ‘irrationally’ underpriced mortgage derivatives you mentioned in another thread, for instance, are only ‘irrationally’ underpriced when one takes the seller’s — as opposed to available buyer’s — opinion of their present worth.

When I watch CNBC and they make similar claims as you do, I’m struck how far against market competition much of Wall Street has become. These same arguments (that market prices do not reflect ‘value’ and should be ignored) were made by feminists in the 1970s and 1980s, who insisted secretarial work was just as ‘valuable’ as managerial work, and therefore redistributive policies were merely correcting an irrational market.

I already blogged a major slum-to-suburb experiment, which ended in predictable failure. [1]

[1] http://www.tdaxp.com/archive/2008/06/13/clearing-the-ghettos.html