U.S. Debt, Today and Tomorrow

[Haggis@wk]

This doesn't look right to me. The homeowner has 20% equity and the mortgage holder has the rest at the time of purchase, don't they?

Not sure what you are trying to say. When I purchased my current home I had to pony up 20% of the asking price to avoid PMI payments and the bank put up 80%. Newer loans have all kinds of permutations so I don't know what a "conventional" loan looks like. I couldn't use the VA Home Loan since I wanted to avoid PMI insurance.

[Giant Communist Robot]

Not sure what you are trying to say.

I don't know much about real estate. Isn't the owner's equity equal to the value of the property minus the mortgage? In the example Shapley and I gave the new owners would have negative equity and unless they had enough assets to cover a cash purchase wouldn't they owe more than they own? Where's our real estate experts when you need them?! Lurking?!

[Shapley]

Greece Selling Off Assets to Raise Capital

On a related note, Greece is having a fire sale.

[Giant Communist Robot]

Greece Selling Off Assets to Raise Capital

On a related note, Greece is having a fire sale.

I think this is part of the German plan. The ECB has some different ideas.

[Shapley]

Not sure what you are trying to say.

I don't know much about real estate. Isn't the owner's equity equal to the value of the property minus the mortgage? In the example Shapley and I gave the new owners would have negative equity and unless they had enough assets to cover a cash purchase wouldn't they owe more than they own? Where's our real estate experts when you need them?! Lurking?!

The mortgage is loaned against the entire property. If the homeowner defaults, regardless of their accumulated equity, the bank assumes ownership of the entire property.

Let us say, for example, I purchase a house of $100,000. The bank, under the old rules, could only loan me $80,000, against which I 'put up' the entire value of the home, or $100,000. Theoretically, therefore, the bank assumes little or no risk in making the loan. I, however, risk my entire down payment of $20,000.

Let us say that, after a few years, I have paid $5,000 in principal, and my area is hit with an economic downturn, such that the value of the house declines by $10,000, and I lose my ability to pay my mortgage, so I default. The bank forecloses. As a result, they assume a house now worth $90,000, of which they have $75,000 invested (the original $80,000 minus the $5,000 principal paid).

In a normal market, they would then sell the home. The would be content to sell it for the $75,000 investment, thus 'breaking even' (which ignores the interest they've earned on the loan prior to my default). However, selling it less than appraised value lowers the value of other homes in the neighborhood. This is due to the fact that appraisals take into account the market history of homes in the area. Since lowering home values is not in their best interest, thus will endeavor to try to sell the home at or near the market value of $90,000.

Let us say that they find a buyer at $85,000. They have thus recovered their initial loan, and have $10,000 over and above their investment. Depending on State law and the terms of the loan, they may or may not be obligated to return to me some or all of that $10,000 excess over my loan, which offsets some of my equity loss.

The bottom line, however, is that they bank 'holds the note' on the full value of the home, which would theoretically always be greater than their investment. Homeowners are obligated to insure mortgaged homes against loss due to fire, etc., further protecting their investment. In many markets, the lender will escrow taxes and insurance,in order to ensure those obligations are met as long as the home remains under mortgage.

[Giant Communist Robot]

Not sure what you are trying to say.

Let me regurgitate:
Shapley said

individuals should not owe more than they own
and nations should be like individuals

I said:

New homeowners ordinarily owe more than they own

Shapley replied:

banks would only lend up to 80% of a home's value, theoretically leaving the homeowner with more equity in the home than debt

...and at this point I'm confused why a homeowner who puts 20% down has more equity than debt

[Giant Communist Robot]

Let us say, for example, I purchase a house of $100,000. The bank, under the old rules, could only loan me $80,000, against which I 'put up' the entire value of the home, or $100,000

It still looks like 20,000 equity and 80,000 debt.

[Shapley]

In the example Shapley and I gave the new owners would have negative equity and unless they had enough assets to cover a cash purchase wouldn't they owe more than they own? Where's our real estate experts when you need them?! Lurking?!

For lending purposes, their total equity is equal to the home value minus the mortgage. However, for purposes of net worth, any equity would be an asset. In calculating net worth you estimate the market value of the home, and subtract any liens against it. Thus, in my example (and negating other assets or debt beyond the mortgage), at purchase my assets were $100,000 (the home), my liabilities $80,000 (the mortgage), leaving me a net worth of $20,000 (the difference).

Prior to defaulting, my assets would have been $90,000 (the revised value of the home), weighed against a liability of $75,000 (the remaining value of the mortgage), leaving me a net worth of $15,000.

Thus, in my example, had I been able to sell the house for the market value prior to defaulting, I would have been able to settle the mortgage for $75,000, and had $15,000 in my pocket and still had a decent credit rating, leaving me with the ability to borrow again.

Which leads us back to the debt/GDP discussion. Just as my reduction in income would have impacted my ability to borrow, even if I had settled the mortgage sans default, so a nation with a reduction in GDP, or a high level of debt weighed against GDP, might find it harder to borrow.

[Shapley]

...and at this point I'm confused why a homeowner who puts 20% down has more equity than debt

equity' is not same as 'assets'. 'Net worth' could be adjudged, for these purposes, to be the same as 'equity', which is to say that which remains after debt. 'Assets' are the value of what is owned, before you subtract debt.

By weighing equity against debt, you are subtracting the debt twice: once to obtain the value of the equity, and then again when comparing the equity against it.

At least that is how I see it.

$100,000 asset
-$80,000 mortgage
________________
$ 20,000 equity (net worth)

[Giant Communist Robot]

So here

For lending purposes, their total equity is equal to the home value minus the mortgage

100,000-80,000=20,000

and here

However, for purposes of net worth, any equity would be an asset. In calculating net worth you estimate the market value of the home, and subtract any liens against it.

100,000-80,000=20,000

[Shapley]

So here

For lending purposes, their total equity is equal to the home value minus the mortgage

100,000-80,000=20,000

and here

However, for purposes of net worth, any equity would be an asset. In calculating net worth you estimate the market value of the home, and subtract any liens against it.

100,000-80,000=20,000

Right, which is to say that, in this example, total debt is 80% of total assets, so debt remains less than assets.

[Giant Communist Robot]

I don't know about this equity/asset difference, but when you buy a house with a loan I'd consider the loan a debt. I don't think it's unusual for people to borrow more than they own in this case. Your argument seems to be that once they buy the house their net worth increases to compensate for the loan. I think.

[Giant Communist Robot]

Right, which is to say that, in this example, total debt is 80% of total assets, so debt remains less than assets.

OK.

[Shapley]

I don't know about this equity/asset difference, but when you buy a house with a loan I'd consider the loan a debt. I don't think it's unusual for people to borrow more than they own in this case. Your argument seems to be that once they buy the house their net worth increases to compensate for the loan. I think.

Yes, exactly. Even though they don't, technically, own the house, it's value is weighed against the debt incurred in purchasing it.

Of course, when you factor in home equity loans, 'zero down' mortgages, reverse mortgages, etc., that throws all that out hte window. But, of course, that's reportedly how we got ourselves into the current economic situation...

[Giant Communist Robot]

You've gone some distance on the individual side for your case, but done nothing for the government. Let's look at some figures from Treasurydirect.gov:

14.4 trillion in Treasuries issued
of that 4.6 is held by the government
and my estimate is 3.5 trillion issued with lower yields than the inflation rate, so this is not a debt but an asset
and I see 2.1 trillion in tax receipts for 2010


but these are just some of the numbers. If, for the individual you consider the value of the house, just what does the government own? Anything of value? Can you say for certain that the government has borrowed more than it owns? I pointed out the government has a right to tax you, as much as they please. This is a big asset. For the life of the longest Treasury issued today, without a tax increase (you wish), it should be worth 80 trillion.

[Shapley]

Can you say for certain that the government has borrowed more than it owns?

Not really. The government hold substantial land holdings, some with considerable mineral deposits, particularly in the West. They also hold the authority, even though they don't 'own' the land, for drilling offshore. Those are considerable assets.

I pointed out the government has a right to tax you, as much as they please. This is a big asset. For the life of the longest Treasury issued today, without a tax increase (you wish), it should be worth 80 trillion.

True, but there is a practical limit to their ability, even if there is no legal limit.

[Giant Communist Robot]

I found two sources that explain the importance of the debt to GDP ratio; both say it reflects the country's ability to repay and so is a measure of the health of the economy. I would still say it's more to the point to look directly at tax revenues than to estimate them from GDP.

I found this interesting number about our debt to GDP ratio here

58.9% of GDP (2010 est.)
53.5% of GDP (2009 est.)
note: data cover only what the United States Treasury denotes as "Debt Held by the Public," which includes all debt instruments issued by the Treasury that are owned by non-US Government entities; the data include Treasury debt held by foreign entities; the data exclude debt issued by individual US states, as well as intra-governmental debt; intra-governmental debt consists of Treasury borrowings from surpluses in the trusts for Federal Social Security, Federal Employees, Hospital Insurance (Medicare and Medicaid), Disability and Unemployment, and several other smaller trusts; if data for intra-government debt were added, "Gross Debt" would increase by about 30% of GDP

...and so I get the feeling here that this claim we're about 100% debt to GDP is political theater, but the bad guy here is still entitlements.

[Shapley]

I've fussed about the use of 'intergovernmental holdings' when calculating debt before. Oftentimes, commentaries on the debt will use statistics that both use and do not use the intergovernmental holdings, without explanation. That only confuses the issue and appears to be, as you say, political theatre.

However, it is worth noting that the vast majority of debt incurred since late 2007 has been public debt. Prior to then, intergovernmental debt rose more or less proportionate to the total debt, averaging (I believe) about 42% of the total debt. It is currently less than 1/3 of total debt. Since October 2007, (which marks the beginning of the DOW's slide, by which I guage the beginning of the economic crisis) intergovernmental holdings have risen by about $650 billion, while public debt has risen by about $4.6 trillion.

[Giant Communist Robot]

I've fussed about the use of 'intergovernmental holdings' when calculating debt

As I've said before, the terms are what's important. Are they paying interest on those loans? What about a repayment schedule? They make it up as they go along.

it is worth noting that the vast majority of debt incurred since late 2007 has been public debt

Indeed. Check those yields, though. Being lower than inflation means, in real terms, they are being paid to borrow. This is what Reinhart and Rogoff (if I have to cite them again I'll just use R&R) call de facto default, since we are allowing inflation to exceed yield. In real terms those people are not going to get paid.

Despite using numbers this Debt:GDP ratio is only a quick and dirty method to look at the health of the economy. Incidentally, R&R say more than half of all defaults occur in countries with a ratio of 60% or less. Default and the ratio are not correlated. So, including all debt we have a ~90% ratio, according to CIA factbook. By the way, because it's high numerically doesn't that mean the ratio is low? Uh...anyway this ratio suggests our economy is not healthy. Surprise! Not exactly a revelation. If one is not careful it's easy to think the ratio points to debt as the problem, but it is only the symptom.

[Haggis@wk]

Federal budget deficit on track to eclipse $1 trillion for third year.

It’s the continuation of record levels of looting.