Step 2 of the Bailout Plan

Step 2 of the housing and banking bailout was announced yesterday evening, when Citigroup, JP Morgan, and Bank of America announced the creation of a Super SIV, apparently funded with $100 billion of their own equity.

A simple Google of SIV and Citibank will bring up tons of articles discussing the relative merits and disadvantages of the proposal. I am instead looking at it as more of a confirmation of the serious issues that exist in the real estate market and now credit markets as well. The real estate is the underlying collateral for most of the debt instruments. The markets for the different types of debt instruments continue to seize up because investors are having a difficult time assessing default risk of the various securities AND the underlying collateral in the case of default.

The SIV bailout proposal which has been authorized will help to create an artificial buyer for the SIV assets - these currently undesired debt instruments (re: subprime mbs, mbs of any kind, CDOs, asset backed commercial paper) and may even succeed in propping up the asset values temporarily. Still the bailout proposal fails to address the problems of the drop in value of the collateral backing the different debt instruments as well the increasing defaults the instruments are experiencing.

As a result - Step 2 of the bailout plan is doomed to fail. As we speak housing prices in Chula Vista, California are down approximately 35% from their 2005 peak. I am revising my estimates from a year or two ago expecting a 50% REAL drop in price (= inflation adjusted) from peak to a 70% REAL drop in price over the next two years (2008-2009). This would put us at residential real estate prices as far back as 2000 and completely erase the home price gains of the past three years.

-BG