Chuck's commentary on Bailout equity effect.

If you thought the last post was too long, here's my summary. The bailout will create a downward equity spiral like the water leaving your toilet.

The commentary at the end of the presentation was not conclusive or convincing.

Here's the basics from the homeowner's point of view.

Let's look at "Whiskey Pete (obviously name has been changed to protect the innocent)" in Las Vegas, NV.

Pete bought a home at the top of the housing market 2.5 years ago for $350k

After the majority of homes in his neighborhood have been foreclosed on, and the 80/20 mortgage has had the 20% second thrown out the window, homes are now selling for $130k.

Pete has not walked away from his home, but now looks at an equity hole of $220k.

The bailout allows Pete to refinance at 85% of his new appraisal.

If the appraisal is honest ($130k) and not artificially deflated (like the artificially inflated appraisal he received when he purchased the home) Pete can now refinance with a balance of $110k (130 X .85).

Wow! Pete has been saved by the government bailout!

Or has He?

The forgiveness of a debt is a TAXABLE EVENT just like income.

Yes, come tax time, Pete will need to pay taxes on his debt forgiveness of $240k. This amount of "paper income" will probably change his tax bracket as well. So Pete will need to find between 15-50% ($36k-$120k) just to satisfy his tax obligation on his "bailout"

UNLESS......

Pete can find a LOSS to offset his debt forgiveness. (like the sale of his home at the new lower value). So Pete Sells his home for $110k, tax liability taken care of.

Now the homes in his neighborhood that the banks are trying to sell at $130k will lose value, because the newest comparable sale is $110k driving all of their values down so the next bailout refi and sale is at $93k (85% of 110k).

Keep in mind, this is IF everyone in the process is HONEST and doesn't intentionally seek a undervalued appraisal.