The Federal Reserve bailed out of the banks, Freddie and Fannie a while back. Just before the real estate bubble burst, houses were sold for big bucks. The seller got the cash from the banks and the buyer got the house, which they gave back to the bank. Notice in a real estate transaction, the buyer normally will over a span of 20 to 30 years, pay back the loan with interest. At this point, the bank has an insurance loss on the home. It’s worth a couple of hundred thousand less than what the bank loaned money on.
What is not real clear here is the economic ramifications of a buyer walking away from a home and living in it for free for one to two years. The Federal Reserve is the insurance company that covers these failed loans and reimburses the banks for their loss. The original seller got 500K for the home and the Federal Reserve picks up the property. The Fed has an IOU written to itself for the amount it covered for the bank, in this case 250K plus the house itself. It now can offer very enticing interest rates to any buyer that would like to purchase the home at say $400K. Since the Federal Reserve doesn’t have to make a profit, the interest charged and the total payments over 30 years will probably cover to total cost that the Feds are on the hook to cover, 500K.
The seller got 500K when the buyer took possession. The bank was made whole with a 250K payment from the Federal Deposit insurance. That 250k was supposed to enter the market slowly over many years out of the buyers paychecks from wages earned. This was money that the homebuyer would not be able to spend on consumption because it was committed to house payments. That is no longer the case. The buyer took a walk, and the deficiency was dumped back into the market as an insurance payoff to the bank. Plus now, the ex-buyer is free to consume other things with his paycheck.
I could be shot again for my generalizations, but if we examine the real estate bubble, the house was well worth 250K pre bubble and sold for 500K. The seller made a 250k profit and the Fed dumped 250K into the banks’ balance sheet. And when you look at it, the money in the banks belongs to the savers, so everything is just terrific nobody has lost a dime. At this point you have 250k (seller profit) + 250k (FR insurance)=500K extra added to the economic market in purchasing power that no one ever even worked for. Now true, if the Fed sells the home for 400k, the 500K will come back to the Fed and we have a zero sum game, the trouble is, that date is 20 to 30 years away.
Where did all of this unearned money go? The answer is not really clear here. It is quite possible that it went into the real estate market, the stock market and IRA’s. If the banks wanted your money real bad, they would pay more than the paltry one percent interest. The one thing that is for certain, the Federal Reserve wants the highest price it can get for the real estate it manages (ergo keep interest rates low). Uncle Sam, the used car salesman, will give you the deal of the century on a used home. The lender of last resort, the Federal Reserve, has taken all risk out of the real estate market. Maybe that’s why the stock market is so inviting, no government controls.
The defaulted loans were a promise by the buyer, to surrender future earnings for the house being purchased. His labor over 20 to 30 years was going to pay for the house in a long drawn out time release program. Well, that didn't happen. The money that the seller received was his to keep. The money lost by the bank was depositor's savings and the amount was made whole again by the Federal Reserve. The sale of just one home worth 250k has blasted the financial market with 500k of money that was never earned by producing product. The funny thing is, all dollars are equal, the one you had to work for is no different than the one that was printed to cover up the real estate fiasco. Common sense suggests, that there is more money out there than there are goods to buy at present prices. And if you don't have a job, this sort of common sense is no consolation when it comes to paying the bills. But if you do have a job, it kind of explains why your paycheck doesn't go as far anymore. Two different perspectives and they are worlds apart.
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