I thought we had gotten passed the confused idea that property is the asset of securitized debt. No, the asset is the debt itself, not the collateral. But here is an article from the UK criticizing Irish Finance Minister Lenihan for valuing securitized debt held by troubled banks at their, “long term economic value.” The writer says he should be getting much lower prices in this, “fire sale of property assets.”
I guess we better take another look at debt as an asset. The typical auto purchase involves a substantial loan with the buyer maybe paying 10% down and financing the rest. The day the auto leaves the lot it loses about one-third its value. If one considers the auto as the value of the loan, the loan has lost just short of one third of its value. But no, the loan is still worth its maturity or long term value, i.e. the balance due, times interest rate, times total payments to be made, minus defaults. A student loan has no collateral so, under the collateral is the value test, the loan is worthless. Ditto credit card debt. But all of these loans have also been bundled into debt instruments sold to investors. Again, the asset is the loan or debt, not the collateral.
The theory of collateralized debt is that failure to pay means forfeit of the collateral. Thus many see the actual value of the loan as the forfeit value. As home prices decline, the collateral on mortgages declines in value. But that does not change the value of the debt itself, it is still balance due, times interest rate, times payments to be made, less foreclosures. No, the collateral is not used as a a value for the loan, but as an incentive for the borrower to repay the loan. To put it bluntly, you pay so you do not lose your home.
Those who have erroneously devalued securitized debt to the depressed values of the underlying collateral justify their error by saying that, if the collateral loses value, the borrower will not repay. However, this has not happened to anywhere the levels envisioned by the panic driven evaluators. The foreclosure rate, while higher than average, has never exceeded 3% of all mortgages.
And why do people in the main still pay on mortgages on homes whose values may now be less than the balance due on the mortgage? I will answer with a question, why do people still pay loans on autos that are clearly worth less than the loan? Why do people still pay on student loans that have no collateral value? Why do people still pay credit card debt on goods and services long gone or used up?
Get real, people pay their debts because there is a whole body of law enforcing repayment and becuase they want to be able to obtain credit in the future. We pay our debts because we want to incur more debt. We pay our mortgages because we want to buy another home in the future. To say that people will not repay a mortgage because the home is no longer worth as much, or less than, the debt incurred to buy it is to question the entire basis for our credit system. We pay our debts because they are our debts.
So the proper valuation of securitized debts is the debt itself, not the collateral. The Irish Finance Minister is entirely correct in valuing securitized debt the government will buy at its, “long term economic value.” But then I am sure there will continue to be many who fail to understand that the asset of securitized debt is the debt itself.