Friday, April 04, 2008

Loaning $$ to Investment Banks vs Help Home Mortgage Owners

The federal government should not be helping home owners who spent beyond their means. Think about it, if banks foreclose on a home they usually take a haircut or a loss because they have to dispose of the property quickly. That loss comes from their current income or if in worst case from the equity of the shareholders (not depositors).

This lowers the price of the home in a low demand environment because the supply of homes is higher than demand (too much supply leads to lower demand). It also reduces the prices of other like properties on the market. This lower price environment allows new home buyers to enter the market as the home prices become more affordable. The new entrants are lower risk and higher quality buyers. So the loss goes to the lender who took the risk and the borrower who mid misjudged their ability to pay.

The Fed should LOAN not bail out investment banks because these banks possess a huge risk to the entire financial framework. In fact the Fed forced the market to take a loss (in this case the Bear shareholders) and is holding on to collateral that will (most likely) not loose its value over time. It is providing a SHORT TERM loan and will unwind this transaction in the future.

Here is a good explanation of why the Fed acted from Paul Kedrosky blog.

'It is important to understand that investment banks now perform many of the economic functions traditionally associated with commercial banks, and they are also vulnerable to a sudden loss of liquidity. Unlike commercial banks, which rely significantly on deposits for funding, investment banks operate according to a business model in which they fund large portions of their balance sheets on a secured, short-term basis in what is known as the repo market. Because the assurance of access to short-term secured funding on a daily basis is such a critical component of business functioning for these entities, they are vulnerable to the possibility of a sudden pullback in short-term lending, or a reduction in the willingness of investors to lend against certain classes of securities'

Think twice when Obama wants to save the homeowners! Yes We Can - save reckless folks!

No comments: