23 Aug 2010

“Indymac Boys Get Sweetheart Deal”

Financial Economics 1 Comment

Bill Butler passes along this interesting video. I am not endorsing the claims but it sounds plausible:

Let me make one observation: Generally speaking, it’s appropriate financially to count it as a “loss” if someone defaults on a note, even if the person had paid less for it. For example, if someone sells me a mortgage with a face value of $200,000, but I think the homeowner will default, I might pay $100,000 for it. Then if I get (in PDV terms computed the day I bought the mortgage) $105,000 out of it, and then the homeowner defaults, my accountants are still going to register the default as a “loss” on my balance sheet. That’s because at the moment of the default, there was still market value associated with the potential stream of remaining payments.

But the thing is, because I take into account that chance of future loss, I pay less for the mortgage upfront than its face value.

What’s going on here–if the details of this video are correct–is that the big boys were allowed to buy at a steep discount, and to be guaranteed full face value by the taxpayers. So they are getting it both ways: If they are guaranteed to be made whole in the case of default, then they shouldn’t be buying at a steep discount, since there’s no risk. So that’s why this whole thing is so shady; it’s not the mere fact that they are calling something a “loss” and using the face value as a benchmark, when they only paid a discounted price for it.

One Response to ““Indymac Boys Get Sweetheart Deal””

  1. Silas Barta says:

    Isn’t that pretty much the story of the *entire* financial crisis/bailout? Well-connected players get compensation on the grounds that they’re taking risks, but then, the moment the investments actually *do* go bad, the government makes up the losses, meaning they were really never taking risk the whole time.