Learn about Wealth Destruction 2 Video

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Learn about Wealth Destruction 2

Learn about Wealth Destruction 2 So what happened in the previous video? We had a nice simple neighbor to 1995. Everyone prudently bought houses with 20% down. They bought it for a $100000 and frankly there’s probably more people who wanted to buy houses then but they couldn’t get financing and that was in place for a reason because you had to prove yourself worthy to get the financing. But anyway, ten years go by financing gets really cheap because you have this dynamic of rising home prices. People down play risk, people willing to give a loan to more and more people and they kind of do that just to keep up with the other banks and you have in 2005 the kind of a peak of the bubble. Someone buys house number one for million dollars with the no money down, sub-primal. And then a year later, they foreclose and the house is auctioned off and it only gets $300,000. But between the times that the house was bought for $1,000,000 and auctioned off for 300000. Let’s say that that’s in, now let me do in year, we’ve sat this is 2008 and now. So 2008, this house gets foreclosed and auctioned for $300,000. And in the mean time, all of this people, let’s say all of them took $500,000 home equity loans, right. So they all have $500,000 of debt from home equity loans plus whatever they have left from their original $80,000 loan. So, you know maybe it is 580000 if they’re only paying interest and maybe a little bit less in that. Let’s just say its roughly $500000 and at first maybe in 2008 they all say, you know what this is temporary, that was just a fire sale price on this auction don’t really reflect a market reality so were just going to sit tight and wait for a housing prices to go up because this wasn’t a real transaction. But let’s say 2009 comes along and this individual, house number two’s owner either has to move has a different job and a different city or maybe they just get, that they laid-off and they can’t pay the morgue anymore and they need to sell their house. Well, they tried to sell their house a little bit and its no coincidence that they try the house for $6,000. They’d sell for $600,000 and no one come for a while and victory starting up because you have a lot of people trying to at least just be made whole in their loan when they sell their house but no one’s buying their house. So at some point they give up, they go to the bank and they say hey bank can I do a short sale or if I sell it for less then I only own debt but the bank’s still pretty confident then they’re like no. If you have a short sale, a short sale is when you pay, when you sell something for less than what you own on it. So in short sale would be like this guy has a five house number two, you say number two. House number two has a five, let’s say $500,000 more huge and if you were able to sell this house for $480,000 and the bank were to agree that 480000 is all he has to pay back then that would be a short sale, right. But the bank says no, you either sold your house or we’re going to foreclose, either pay us to the debt or we’re going to foreclose on you. So the guy says, sure you know what I have nothing to lose, I’ve just lose my job, here are the keys to the house foreclose on it. And so the bank says, okay I foreclose on it and the bank realizes in a few months that was a bad decision because now when they auction the house they don’t get even 580, they don’t get $480000 for it, they get $250000 for it. And all of this sounds like a very extreme example, things not that different than what I’m describing happen in places like Modesto and stack in California and parts of Miami and Nevada and Arizona. But anyway, so auctions for $250,000 now everyone in the neighborhood gets scared because this guy made house number two be in honest effort to sell, couldn’t sell, try to do short sale, couldn’t do a short sale and when the bank auctioned, they’d actually auction it off less than house number one whose 250000. So now all of this people say what I’m doing, I’m working three jobs to pay a $500000 mortgage on a house that’s probably worth $250000 and if someone really were to be rational about it, 250,000 isn’t some crazy lowball price. They paid a 100000 for it and maybe if you adjust that for GDP growth or inflation, that 100000 in 2009 dollars might be a 150 or $200,000. So 250,000 actually isn’t a crazy price. But anyway, I’ll just keeps at, well I’m why do I keep working so hard, being an intentioned servant to this mortgage. I’m just going to give the keys back to the bank it is called jingle mail. So you give the keys back to the bank, let’s say this guy gives his key back to this bank, this bank that thought that they had made a prudent loan. This was house number three I think so they give the keys back to the bank instead of paying of the loan and this bank says, oh boy now I have this house, they auction it off, they get $250,000, right. So what happen to the bank, the bank had a $500,000 loan out and got $250,000 back. And also, this person has also lost all of their equity in their house that they originally had, right. House number three lost their house, so how much wealth is gone from each person’s perspective? Well the bank had given $500,000 of real capital, real money that could have been used to build a factory to plant some crops. To work on research and development that might have developed in a new materials or new technologies that was real $500000 of capital and now they have, they got a house and they auction off that house and they got $250,000, right? So they got, they lost $250,000 and this individual number one, what did they lose? Well, they lost by entering into this transaction essentially, they lost that whatever equity they originally had their in there house. And what equity would they have had in their house? Well they had, let’s just say they had $20000 of equity before they did this transaction, right. So they lost that $20,000 of equity and frankly, they could have sold that $100,000 house for 250, right? We know even in this quote and quote tough real estate market they could have sold it for 250. So, they really had— let’s see they had an $80,000 loan with $250 asset so they really had— let’s see that’s a 250 minus 80 that’s 170. So they really had a $170000 of lost equity if I’m doing my math right. But I think you get the point so they did build some equity through housing appreciation just the house didn’t go from a 100000 to a 1000000 what from a 100 to 250. So their equity was actually 20000 plus the 150 that they got from just the increasing asset value. If they didn’t enter into this transaction— so they would have another 170,000 of equity that they lost. So, the homeowner lost 170000. So combine to these two parties by entering into this transaction, how much did they lose? Is it 300, they lost $420000, 420,000 was just wiped out it would just disappeared from the economy and where did it go? And you will say, well, you know that they existed in some point, must have gone some place what was consumed it went into this granted countertops and this hardwood floors and this vacation is pure consumption. You could argue maybe some of its investment if it helps you become more productive. But for the most part, that’s pure consumption, things like wood floors and the two more bathrooms in the great countertops. There is some value there but that value is definitely not equivalent to the amount of money that was spent on that they were depreciating assets, they’re luxury goods, and they’re probably according to the taste of the person who did it. But anyway, the whole point of this video is when you have this asset bubbles like in real estate and you have this down playing of risk and this psychology that in asset class could only go up and then people start to have an inflated notion of what the assets are worth and start to borrow against dozens and leverage up against those inflated notions. You have a misallocation of wealth and essentially, a lot of resources end up getting destroyed. Resources that could have built factories, could have built schools, could have built roads, whatever they end up building great countertops and sending people on vacation and making them feel good to go stop start shopping in Williams Sonoma or even Marcus or whatever and all of that is essentially just consumption that just destroys wealth. So this just disappears and I want to make this point because we have a government now that somehow thinks that it can legislate away real wealth destruction. It thinks that, you know what if we just somehow vibe this loan from this bank, this $500,000 loan, if we buy it from that and if we were to hold long enough maybe the underlying asset does or the house just for close on so we don’t even have the loan anymore, we have the house. So maybe the government says, “Oh. Well, what if we just buy this house and hold it long enough? Maybe it will get back to a $1,000,000.” It may get back to a million if our population increases so much that one day that might become a productive asset again or become a high demand asset or it might not ever go. It might be a house that was built in the middle of nowhere, that’s not really useful to anyone and if anything is going to be a place where squatters start to come and the whole place is going, turns to in this empty neighborhood. Who knows, but the bottom-line is, the government somehow thinks that once things get bad it can step in and try to not let people realize that they have destroyed wealth and I call that legislating against reality and reality is something its very hard to do anything against to whether you want to legislate against it or speak against it or perceive a universe that’s not in accordance with it. But anyway, this is a crack of the issue but what that said, I don’t want to seem like one of this defeatist people or who says that there’s no solution to the credit crunch where in particular In particular, this banking crisis were dealing with right now and the next video I give you propose solution that was actually suggested to me by a friend from business school. And actually, I think it makes a lot of sense if you think that the credit freeze is going on is the cracks of the issue.

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Learn about Wealth Destruction 2

So what happened in the previous video? We had a nice simple neighbor to 1995. Everyone prudently bought houses with 20% down. They bought it for a $100000 and frankly there’s probably more people who wanted to buy houses then but they couldn’t get financing and that was in place for a reason because you had to prove yourself worthy to get the financing.

But anyway, ten years go by financing gets really cheap because you have this dynamic of rising home prices. People down play risk, people willing to give a loan to more and more people and they kind of do that just to keep up with the other banks and you have in 2005 the kind of a peak of the bubble. Someone buys house number one for million dollars with the no money down, sub-primal. And then a year later, they foreclose and the house is auctioned off and it only gets $300,000.

But between the times that the house was bought for $1,000,000 and auctioned off for 300000. Let’s say that that’s in, now let me do in year, we’ve sat this is 2008 and now. So 2008, this house gets foreclosed and auctioned for $300,000. And in the mean time, all of this people, let’s say all of them took $500,000 home equity loans, right. So they all have $500,000 of debt from home equity loans plus whatever they have left from their original $80,000 loan.

So, you know maybe it is 580000 if they’re only paying interest and maybe a little bit less in that. Let’s just say its roughly $500000 and at first maybe in 2008 they all say, you know what this is temporary, that was just a fire sale price on this auction don’t really reflect a market reality so were just going to sit tight and wait for a housing prices to go up because this wasn’t a real transaction.

But let’s say 2009 comes along and this individual, house number two’s owner either has to move has a different job and a different city or maybe they just get, that they laid-off and they can’t pay the morgue anymore and they need to sell their house. Well, they tried to sell their house a little bit and its no coincidence that they try the house for $6,000.

They’d sell for $600,000 and no one come for a while and victory starting up because you have a lot of people trying to at least just be made whole in their loan when they sell their house but no one’s buying their house. So at some point they give up, they go to the bank and they say hey bank can I do a short sale or if I sell it for less then I only own debt but the bank’s still pretty confident then they’re like no.

If you have a short sale, a short sale is when you pay, when you sell something for less than what you own on it. So in short sale would be like this guy has a five house number two, you say number two. House number two has a five, let’s say $500,000 more huge and if you were able to sell this house for $480,000 and the bank were to agree that 480000 is all he has to pay back then that would be a short sale, right. But the bank says no, you either sold your house or we’re going to foreclose, either pay us to the debt or we’re going to foreclose on you.

So the guy says, sure you know what I have nothing to lose, I’ve just lose my job, here are the keys to the house foreclose on it. And so the bank says, okay I foreclose on it and the bank realizes in a few months that was a bad decision because now when they auction the house they don’t get even 580, they don’t get $480000 for it, they get $250000 for it.

And all of this sounds like a very extreme example, things not that different than what I’m describing happen in places like Modesto and stack in California and parts of Miami and Nevada and Arizona. But anyway, so auctions for $250,000 now everyone in the neighborhood gets scared because this guy made house number two be in honest effort to sell, couldn’t sell, try to do short sale, couldn’t do a short sale and when the bank auctioned, they’d actually auction it off less than house number one whose 250000.

So now all of this people say what I’m doing, I’m working three jobs to pay a $500000 mortgage on a house that’s probably worth $250000 and if someone really were to be rational about it, 250,000 isn’t some crazy lowball price. They paid a 100000 for it and maybe if you adjust that for GDP growth or inflation, that 100000 in 2009 dollars might be a 150 or $200,000. So 250,000 actually isn’t a crazy price.

But anyway, I’ll just keeps at, well I’m why do I keep working so hard, being an intentioned servant to this mortgage. I’m just going to give the keys back to the bank it is called jingle mail. So you give the keys back to the bank, let’s say this guy gives his key back to this bank, this bank that thought that they had made a prudent loan. This was house number three I think so they give the keys back to the bank instead of paying of the loan and this bank says, oh boy now I have this house, they auction it off, they get $250,000, right. So what happen to the bank, the bank had a $500,000 loan out and got $250,000 back. And also, this person has also lost all of their equity in their house that they originally had, right.

House number three lost their house, so how much wealth is gone from each person’s perspective? Well the bank had given $500,000 of real capital, real money that could have been used to build a factory to plant some crops. To work on research and development that might have developed in a new materials or new technologies that was real $500000 of capital and now they have, they got a house and they auction off that house and they got $250,000, right? So they got, they lost $250,000 and this individual number one, what did they lose?

Well, they lost by entering into this transaction essentially, they lost that whatever equity they originally had their in there house. And what equity would they have had in their house? Well they had, let’s just say they had $20000 of equity before they did this transaction, right. So they lost that $20,000 of equity and frankly, they could have sold that $100,000 house for 250, right? We know even in this quote and quote tough real estate market they could have sold it for 250.

So, they really had— let’s see they had an $80,000 loan with $250 asset so they really had— let’s see that’s a 250 minus 80 that’s 170. So they really had a $170000 of lost equity if I’m doing my math right. But I think you get the point so they did build some equity through housing appreciation just the house didn’t go from a 100000 to a 1000000 what from a 100 to 250. So their equity was actually 20000 plus the 150 that they got from just the increasing asset value.

If they didn’t enter into this transaction— so they would have another 170,000 of equity that they lost. So, the homeowner lost 170000. So combine to these two parties by entering into this transaction, how much did they lose? Is it 300, they lost $420000, 420,000 was just wiped out it would just disappeared from the economy and where did it go?

And you will say, well, you know that they existed in some point, must have gone some place what was consumed it went into this granted countertops and this hardwood floors and this vacation is pure consumption. You could argue maybe some of its investment if it helps you become more productive. But for the most part, that’s pure consumption, things like wood floors and the two more bathrooms in the great countertops.

There is some value there but that value is definitely not equivalent to the amount of money that was spent on that they were depreciating assets, they’re luxury goods, and they’re probably according to the taste of the person who did it. But anyway, the whole point of this video is when you have this asset bubbles like in real estate and you have this down playing of risk and this psychology that in asset class could only go up and then people start to have an inflated notion of what the assets are worth and start to borrow against dozens and leverage up against those inflated notions.

You have a misallocation of wealth and essentially, a lot of resources end up getting destroyed. Resources that could have built factories, could have built schools, could have built roads, whatever they end up building great countertops and sending people on vacation and making them feel good to go stop start shopping in Williams Sonoma or even Marcus or whatever and all of that is essentially just consumption that just destroys wealth.

So this just disappears and I want to make this point because we have a government now that somehow thinks that it can legislate away real wealth destruction. It thinks that, you know what if we just somehow vibe this loan from this bank, this $500,000 loan, if we buy it from that and if we were to hold long enough maybe the underlying asset does or the house just for close on so we don’t even have the loan anymore, we have the house. So maybe the government says, “Oh. Well, what if we just buy this house and hold it long enough? Maybe it will get back to a $1,000,000.”

It may get back to a million if our population increases so much that one day that might become a productive asset again or become a high demand asset or it might not ever go. It might be a house that was built in the middle of nowhere, that’s not really useful to anyone and if anything is going to be a place where squatters start to come and the whole place is going, turns to in this empty neighborhood.

Who knows, but the bottom-line is, the government somehow thinks that once things get bad it can step in and try to not let people realize that they have destroyed wealth and I call that legislating against reality and reality is something its very hard to do anything against to whether you want to legislate against it or speak against it or perceive a universe that’s not in accordance with it.

But anyway, this is a crack of the issue but what that said, I don’t want to seem like one of this defeatist people or who says that there’s no solution to the credit crunch where in particular In particular, this banking crisis were dealing with right now and the next video I give you propose solution that was actually suggested to me by a friend from business school. And actually, I think it makes a lot of sense if you think that the credit freeze is going on is the cracks of the issue.

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