Saturday, January 05, 2008

Exaggerating sub-prime losses

Many expect sub-prime related losses to rise sharply. But some of the estimates appear to be on the wilder side- the figure of $400 bn, which is the upper end of present estimates, for instance.

Bloomberg columnist Jonh Barry explains why:

There are two reasons why the losses aren't likely to be so large.

First, the mortgages are backed by collateral, a house or condominium, and in a foreclosure a home typically retains significant value. When it is sold, the lender often will get 50 percent to 60 percent or more of the loan amount after foreclosure expenses.

Second, most subprime borrowers aren't going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.

To reach a $300 billion loss would require foreclosures on about half of all subprime mortgages with a 55 percent recovery upon sale of the property. And a $400 billion loss would take about a 60 percent foreclosure rate with recovery of about half the value from the sale.

1 comment:

Anonymous said...

Bloomberg columnist is making the same mistake as most of the hosing market journalists made, which is that they are assuming that the current set of subprime mortgages are similar to the historical subprime mortgages, which is not true in the current cycle.(Ex: no downpayment loans are not the norm before)

The assumption that the subprime mortgage will retain 50-60% of the value is valid only if the house is not inflated. if you add 10% or 30% as housing bubble induced inflated value then you will only be getting 50-60% of left over as a best case scenario.

If you include the scenario of no downpayment mortgages then the value might go down furhter.