From: bzs@ussr.std.com (Barry Shein)
Subject: Re: Efficiency
Organization: The World
	<1992Sep4.034400.12110@odi.com> <1992Sep4.141345.10356@spdcc.com>
	<1992Sep6.035842.14635@odi.com>
Date: Sun, 6 Sep 1992 05:39:43 GMT


From: dlw@odi.com (Dan Weinreb) [responding to Bob Donahue]
>			   Just where did all the S&L $$$ magically disappear
>   to?  
>
>As I understand it, when you look at the economy as a whole, money
>really did disppear.  You have to keep in mind that money isn't a
>physical stuff subject to consevation of mass.  Money is based on
>faith (well, "hope" is probably more accurate).  When the speculative
>bubble collapses and everybody realizes that their hopes were
>inflated, debtors start defaulting and creditors start recognizing
>losses by writing off bad loans, and the money just disppears into
>thin air.

Well, it's not quite that simple (or perhaps put better, it's simpler
than that.)

A lot of this problem was due to real estate speculation.

A typical case would be that you [real estate speculator] buy an
office building for $5M, borrowing the money from a bank (S&L.)

The real estate market collapses, and the building is only worth $2M.

So you default because you can't keep up the mortgage payment and
besides, you don't want to pay $5M for a $2M building, others around
you are beginning to pick up the now cheaper buildings so their rents
are lower, the rent you need to pay off a $5M building of this sort is
not sustainable. You're bust, most likely.

Now the bank has a $2M building and a $5M (approx) bad mortgage. Where
did the other $3M go?

Well, it went to whoever it was you bought the building for $5M from,
but of course they're long gone and got their money fair and square
(in most cases.)

Similarly, people who borrowed big bux to build in the real estate
boom gave the money to the builders, furnishers and architects etc.
It went somewhere. Sometimes it went into the builders' pockets, it's
not utterly unreasonable to pay yourself a fee or salary while doing
all this. One source of abuse revolved around when that was
unreasonably done (e.g. paying yourself $1M to "supervise" the
construction of a $5M building which you then default on, not
personally of course, your "corporation" defaults, you keep the $1M.)

What is not conserved is collateral value. Suddenly the bank has, say,
$200M in mortgages (some good, some bad, some indeterminate) but only,
say, $100M in collateral (due to the drop in real estate prices) to
back it up. That's not acceptable for a bank (well, some ratio like
that is not acceptable.) Down and down it goes.

This is why the banks took it in the ear. That alone is a problem, the
question is whether or not illegal/immoral/unethical acts occurred
that either caused or exploited the situation.

For example, trying to ride out the storm by offering the public
unrealistically high interest rates (e.g. CD's) to attract cash into a
sort of Ponzi scheme, hoping you can use the new cash to ride it out
and that the new depositors won't ask for their money back before you
straighten things out. And then you don't straighten things out, or
maybe you never really intended to...

Where Dan may be right is when a bank has a mortgage on a $5M
building, it collapses to $2M, but they keep it on the books as $5M
trying to use it as collateral or apparent assets in order to foster
other manipulations. From some point that excess $3M is pure vapor and
doomed to be lost. That's where some of the illegality/unethicality
may lie.

The stock market handles these situations better, they have something
known as a "margin call". Long before that $5M building goes to $2M,
by wall st's rules, they'd make sure you show how you're going to
cover the slippage (e.g. when it hits $4.5M you either put up the
missing $.5M in collateral or get defaulted right there and the bank
can sell you out.) Of course, sometimes it happens too fast (in both
markets.) And generally mortgages can't be called like this, there's
just no legal (or, more likely, practical) footing to it.

It's all rather complicated.

>Unfortunately, as you can see from what the Fed has been doing,
>infusing money isn't really doing the trick very well.

The thing that scares the hell out of me is: Maybe it *is* doing the
trick well. Meaning that we'd be in the depths of another Great
Depression without their machinations. And may be anyhow as soon as
the well runs dry, unless the economy turns itself around first of
course.

--
        -Barry Shein

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