WHEN IS A "LOSS" REALLY A LOSS?

We're being told on a daily basis how much is being lost as a result of the sub-prime mortgage crisis. I agree that it's a rotten situation, caused by the greed of both borrowers and lenders, and spreading pain throughout the entire economy. It is also a case---and I hope you'll find this helpful---of how the naive media are confusing the naïve public, and perhaps compounding the problem due to accounting semantics. If we feel depressed economically, we act depressed economically. If things REALLY aren't as bad as they seem, our national economic spirit might get perky. Read on. When do you incur a loss? If you put five bucks on number seven on the roulette table, and the ball falls into slot twelve, you've lost five bucks. It's gone. Fuggedaboudit. If you bet $50 on Shady Lady to win the fifth race at Santa Anita, and she comes in second by a nose, you've lost $50. Gone without a trace. If you total your new $50,000 Chevrolet Subdivision by smashing it into a wall and you don't have insurance, you've lost $50,000. Pfffft! Deal with it. But a lot of incidents that are called "losses" really are NOT losses. In the financial world that happens quite a lot. Call it "accounting semantics" if you will. The fact is that things are not always as dire as the word "loss" may make it seem. The media have gone overboard in recent months reporting the "losses" suffered by banks, brokerage firms and investors because of the sub-prime mortgage chaos. The articles spook the markets. Investors sell out and run for cover. The affected stocks go into free-fall. And the headline writers go back to work scaring their readers about the plunge. Bad news is largely a knee-jerk self-fulfilling prophecy. MISSED PAYMENTS DO NOT EQUAL "LOSSES" The fact that payments are not being made on a loan does not necessarily mean that the amount of the loan is "lost." Joe has a loan from his bank of $2,400, payable at $100 per month for 24 months (plus interest.) Joe makes his payments for six months and then stops. He still owes the bank $1,800. Two months, four months, six months go by with no payments from Joe. Has the bank lost $1,800? No. Joe might catch up on what he owes, and the bank doesn't lose a penny. Or, Joe might refinance the loan, thus giving the bank a chance to get all its money back. Again, no loss. When Joe misses payments, his loan might be considered "non-performing," or "delinquent" or "in collection." But until Joe completely abandons his debt, "loss" has not occurred. There's always a chance that Joe will make good on the loan. People who have been saddled with high interest rate mortgages might scrimp and save….OR inherit….OR get a nice raise….OR win the lottery….OR work harder and spend less, OR sell their home to free up some cash….OR finish paying other debts so they can resume payments on their mortgage….OR sell some unimportant assets so they can get square with the debt on their important asset, their home….OR negotiate a new and comfortable repayment plan with the lender….OR add a co-signer to their IOU to give the bank more security, OR…. OR…. OR…. etc. You get the picture. There are a lot of ways that people can and will honor their obligations. But the media aren't recognizing that important fact. Likewise with foreclosures. Yes, the number of new foreclosures is frightening, but the VALUE of the properties that are being foreclosed is not necessarily LOST. Most of those houses will be resold, and their loans taken over (or replaced) so that a high percentage of the original foreclosed loan will go back on the books as a good loan. LIKE YOU, LENDERS SET ASIDE FOR "RAINY DAYS" The lender might, at some point in Joe's delinquency, designate Joe's loan as "Uncollectible." Lenders know that this will happen with a certain percent of their loans, so they set up a "Reserve For Bad Debts." Each month or quarter they take some of their income and put it into this "bad debt kitty." It's like you putting away a few dollars every so often to cover yourself for that "rainy day." When Bad Debts in the Reserve are paid off, that inflow of money counts as current income. When times turn bad the Reserve is topped off. And so it goes. In the sub-prime mortgage situation, a huge amount of money has been transferred into the Reserve for Bad Debts by the lenders. The problem is that the media reports give the impression that the money being put into the Reserve is money that has been LOST. The fact is that a good chunk of those "bad" debts could be repaid. But that repayment doesn't get reported in the mass media. It's lost in the auditors' mumbo-jumbo many months later, and the public doesn't know about it. Unfortunately, Accounting Semantics 101 is not taught in Journalism Schools. And only experienced financial journalists pick up the meanings during their tenure. Meanwhile---given uninformed or imitative reporters and editors---the public is getting its collective head filled with jargon that can be meaningless and misleading. You have to educate yourself if you want to be on top of the game and know how to deal with gobble-de-gook.