{"id":10222,"date":"2015-07-20T06:47:53","date_gmt":"2015-07-20T11:47:53","guid":{"rendered":"http:\/\/olduvai.ca\/?p=10222"},"modified":"2015-07-20T06:47:53","modified_gmt":"2015-07-20T11:47:53","slug":"we-need-a-crash-to-sort-the-wheat-from-the-chaff","status":"publish","type":"post","link":"https:\/\/olduvai.ca\/?p=10222","title":{"rendered":"We Need a Crash to Sort the Wheat from the Chaff"},"content":{"rendered":"

We Need a Crash to Sort the Wheat from the Chaff<\/a><\/h3>\n

Once the phantom collateral vanishes, there’s no foundation to support additional debt and leverage.<\/i><\/p>\n

When a speculator bought a new particle-board-and-paint McMansion in the middle of nowhere in 2007 with nothing down and a $500,000 mortgage, the lender and the buyer both considered the house as $500,000 of collateral.<\/b>\u00a0The lender counted the house as a $500,000 asset, and the speculator considered it his lottery ticket in the housing bubble sweepstakes: when (not if) the house leaped to $600,000, the speculator could sell, pay the commission and closing costs and skim the balance as low-risk profit.<\/p>\n

But was the house really worth $500,000?<\/b>\u00a0That’s the trouble with assets bubbles inflated by central-bank\/central-state intervention: when inefficient companies and inflated assets are never allowed to fall\/fail, it’s impossible to tell the difference between\u00a0real collateral<\/i>\u00a0and\u00a0phantom collateral<\/i>.<\/p>\n

The implosion of the housing bubble led to an initial spike of price discovery.<\/b>\u00a0The speculator jingle-mailed the ownership of the poorly constructed McMansion to the lender, who ended up selling the home to another speculator who reckoned a 50% discount made the house cheap for $250,000.<\/p>\n

But what was the\u00a0enterprise value<\/i>\u00a0of the property,<\/b>\u00a0that is, how much revenue, cash flow and net income could the property generate in the open market as a rental? Comparables are worthless in terms of assessing collateral, because assets are mostly\u00a0phantom collateral<\/i>\u00a0at bubble tops.<\/p>\n

Let’s assume the enterprise value based on market rents was $150,000. The speculator who bought the house for $250,000 sold for a loss, and at the bottom of the cycle the house finally sold for its true value of $150,000.<\/p>\n

Leveraged 20-to-1, the lender’s loss of $250,000 in collateral\/capital unhinged $5 million of the lender’s portfolio<\/b>\u00a0as the capital supporting those loans vanished.<\/p>\n

The first speculator who put nothing down suffered a loss of creditworthiness, and the second speculator lost $100,000 plus commissions when he dumped the property for a loss.<\/p>\n

 <\/p>\n

…click on the above link to read the rest of the article…<\/p>\n","protected":false},"excerpt":{"rendered":"

We Need a Crash to Sort the Wheat from the Chaff Once the phantom collateral vanishes, there’s no foundation to support additional debt and leverage. When a speculator bought a new particle-board-and-paint McMansion in the middle of nowhere in 2007 with nothing down and a $500,000 mortgage, the lender and the buyer both considered the […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_monsterinsights_skip_tracking":false,"_monsterinsights_sitenote_active":false,"_monsterinsights_sitenote_note":"","_monsterinsights_sitenote_category":0,"footnotes":""},"categories":[2],"tags":[127,4889,173,235,406,7195,4924,2589,868],"class_list":["post-10222","post","type-post","status-publish","format-standard","hentry","category-economics","tag-charles-hugh-smith","tag-collateral","tag-crash","tag-economic-bubbles","tag-housing-bubble","tag-market-bubble","tag-oftwominds","tag-value","tag-wealth"],"_links":{"self":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/10222","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=10222"}],"version-history":[{"count":1,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/10222\/revisions"}],"predecessor-version":[{"id":10223,"href":"https:\/\/olduvai.ca\/index.php?rest_route=\/wp\/v2\/posts\/10222\/revisions\/10223"}],"wp:attachment":[{"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=10222"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=10222"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/olduvai.ca\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=10222"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}