I don't understand the credit market at all

[MrCoffee]

So the Fed is handing out $200 billion in loans backed by "unmarketable" mortgages in an attempt to inject liquidity into the credit market. Ok, that didn't seem to work with the billions they already pumped into that market, but, you know, whatever.

What happens when the loans have to be repaid? How do the Fed loans translate into new, less risky mortgages for people trying to buy a house? I'm not an economist by any stretch, but this makes zero sense to me.

[PDJane]

1. Congratulations.

That is because it makes no sense.

[MrCoffee]

2. Woo Hoo!

Wait, this doesn't feel like one I want to win...

[DJ13]

3. How do the Fed loans translate into new, less risky mortgages

Thats not what the Fed is doing, though it should be if they wanted to address the root of the credit crisis.

The current Fed actions are designed to do nothing more than to try and shore up the balance sheets of the financial institutions, thereby (in theory) helping the stock market.

The GOP has a bad habit of assuming the stock market represents the actual economy, likely due to the influence of corporations and their large campaign finance influence, so their hand picked Fed chief believes his his main job is to prop up the stock market.

[MrCoffee]

4. See, that's what my first thought was

That this is nothing more than a way to get banks (and the NYSE) through the next quarterly report.

[JackRiddler]

Nope.

It's to get the NYSE through the next week.

[Dreamer Tatum]

15. You are forgetting something

The whole purpose of the GSEs, and a useful function of MBS, is to provide liquidity so that people could
borrow for mortgages. Very few people would have, or even qualify for, mortgages in which the local bank
has to originate and service the loan.

If there is going to be any liquidity for people to buy homes at decent interest rates, the government pretty
much has to do something like this. If you think this is just a payout to lenders, go glance through the
stock performance of every entity lucky enough to be standing. A lot of very stupid and greedy executives
saw their stock options vanish. $200B to help ease borrowing for homes is not all that much.

[selador]

5. here is how it works

i could spend hours and hundreds of pages on it.

i won't.

in brief, the credit market is a risk pricing and risk offsetting device.

mortgages aren't risky for people buying a house. they are not assuming risk. you have it backwards. the BANKS are assuming risk when they underwrite a mortgage. you purchase a mortgage, you know EXACTLY what your obligations are (if you read the frigging thing). the bank does NOT know what its receipts will be. cause you could default.

you are paying for them to assume risk. you have an obligation to pay them and that payment pays them for the risk they are taking.

that's how it works.

part of the price of a mortgage is the cost of money to the banks. the fed affects that by pricing overnight loans, etc. that's what the fed does to loosen or tighten money- it makes it cheaper or more expensive to access it.

many of these mortgages simply have no bid in the secondary market because traders feel the risk is too high. they are just not payin' up

what the fed did yesterday is agreed to lend up to 200 billion in treasury securities (theoretically risk free) in exchange for debt, to include MORTGAGE BACKED SECURITIES. it will allow the borrowing of treasureies (note: BORROWING) in exhange fannie may and freddie mack backed bonds and mortgage securities AND (this is a big one) even mortgage backed securities that are NOT backed by fannie and freddie as long as the debt is rated triple-a (don't even get me started on the rating system )

the auctions will start march 27

[jpljr77]

7. Right. And further...

the Fed did it to shore up liquidity among credit grantors. When the whole credit system was teetering on the brink of disaster, the banks reacted by closing the money spigot used to douse consumers with credit. The Fed is hoping this injection will allow banks to loosen lending standards and get more credit into the hands of Americans.

In short, they did it so that we could spend more on credit. No joke.

[MrCoffee]

9. So the idea is that it'll be easier to get a mortgage, thanks to the loan?

Is that right?

[selador]

10. in brief

yes. assuming the banks play along

the banks are in it to make money, and protect capital.

they have been more concerned about the latter (since so many got SO spanked).

this move makes the former more likely, as well as the latter.

or at least it appears to do so :)

[Javaman]

17. But given the present landscape of loan defaults and foreclosures

and recent changes in who can barrow money, doesn't this make for, not only a gun shy public wanting to get a mortgage or buy a home at all? And given the fact that so many people have lost their homes to ARM's that there are now fewer people out there to buy a home?

Isn't this a little like closing the barn door after the horse is gone?

[selador]

18. some would say yes

the argument is that

there are a lot of people one the sideline who want to buy a home NOW that prices have dropped. but need financing. heck, i sold one of my homes last year for a very tidy profit and will sell my other one and move up to a much nicer one ONCE this seattle/king county market corrects (drops in price). many other markets have corrected/crashed and there are people who want to buy.

supply and demand waxes and wanes. supply has seriously outstripped demand (that's why prices fall) and there are a lot of just built, just sold, want to be sold, and in the process of being built houses on the market. unsold inventory as a % is at all time highs.

basically, the fed is trying to help trade get facilitated.

the whole multiplier effect. homes sitting unoccupied and/or half built does not help the economy

[jpljr77]

11. Kind of.

The thought is it will be possible to get a loan period. Where things were headed, credit was about to freeze up entirely.

You see, banks don't lend their own money when they make credit loans. That would be ludicrous. Instead, they back the money they lend with assets or investments, or they borrow it themselves from the Fed or other banks. That activity was drying up as they lost billions on bad loans.

There are also a whole lot of regulations that require banks to keep a certain amount of assets in relation to loans they make and deposits on record. But I don't know the exact numbers and it makes my junk hurt just thinking about it.

[MrCoffee]

12. Not to keep beating this particular horse, but what happened to the last liquidity injection?

Didn't the Fed dump hundreds of millions into the credit market a couple of months back?

[MrCoffee]

8. But the ARM's are "risky" for the banks in that they are the ones defaulting, right?

So the Fed move is intended to get banks lending in more traditionally "stable" mortgages? Is that the purpose?

My understanding is that the default rate on mortgages is what started the problems in the credit market. So the "riskier" (from the bank's perspective) mortgages are those more likely to result in default (ARM's, stated-interest, etc.) Isn't that why these mortgages are now unmarketable, and why the credit market is a mess?

I still don't know what happens when the Fed loans have to be repaid. What's going to generate the money needed to buy back the debt? Who is going to end up with the collateral when the loan comes due? How will these loans fix the underlying problem with the loans used for collateral to purchase the securities?

[selador]

13. sure

banks don't want (theoretically) to write a loan where the risk of default offsets the added value from the increased interest a higher interest borrower pays.

iow, they want to hit that sweet spot, where they are adding value - the increased risk of default on risky loans is offset to a larger extent by the higher interest.

now, a big part of the pciture was that banks sold off these mortgages and they were split up into all sorts of derivative instruments (don't even get me started on tranches etc.)

put briefly, the banks were writing riskier loans because OTHERs were buying the risk from them. then, these people split up these instruments into all sorts of exotic derivatives, all in search of more yield.

many of these buyers heavily leveraged their purchases of these instruments, thus increasing potential reward as well as risk.

if they were borrowing money at 4% to buy something that (theoretically) paid them 6% yield, that's a "no brainer".

so, what do you do, you borrow more. heavily leveraged borrowing so you can squeeze out more $$$ from that spread (6%-4% used for illustration only.

you last question is hard to answer. essentially, part of this is a fundamentals problem and part is a confidence problem. basically, it's like insurance. the banks have the backing of the federal govt. with the these loans, and 'safe' money can be more easily confidently lent. the collateral IS the mortgage paper that the banks are exchanging

[A HERETIC I AM]

14. Awww, come on.

I'm going to poke you to try and get you started.

:: Poke Poke:::

(don't even get me started on the rating system )

(don't even get me started on tranches etc.)

Come on. I'm dying to know how you feel about the "rating system" and "tranches etc"

[selador]

16. (fingers in ear)

IM NOT LISTENING...

ok...

as for tranches... two words.

think ORANGE COUNTY (redux)

the problem with ratings is the problem with any analyst rating. trying to ferret out the subjective rubbish from the meat.

it's not quite henry blodgett biased, but well...

[Hawkowl]

6. Taxpayer bailout

Essentially when the Fed (an arm of the federal government) guarantees the unmarketable mortgages, it means that this formerly bad asset is now marketable and thus is no longer bad. This will prop up the banks balance sheets because these assets are no longer close to worthless because the Fed has essentially issued a de facto guarantee that the government will take these bad mortgages as collateral.

In order for a bank to be able to loan out money, the bank must have more assets (loans made to customers) than liabilities (cash on deposit that it owes it's customers). Think of the bank paying you 3% on your savings account and charging you 28% on your credit card. Sweet deal--for the bank. Now the tricky part is the fact the bank doesn't have to keep your entire savings account on hand. It only has to maintain a cash reserve of I believe 10% and can loan the other 90% out for people to buy houses or cars or whatever.

So if all the sudden the people who owe money to the bank can't pay back their loans and the houses, or cars are no longer worth the original amount of the loan, the bank suddenly can no longer pay YOU back if you want your savings account right now. This means the bank can't make any additional loans to anyone at any interest rate. Thus we have a "credit crunch" or a "liquidity crisis". This is why the Fed keeps trying to pump money into the banking system by lowering interest rates and making guarantees. Because if it lets all these banks fail, no one will be able to buy anything on credit, which means fewer goods and services being produced, meaning way fewer jobs and a very steep downward cycle of recession and unemployment.