Does that mean the homes are worth 11-27% of what they were when the mortgages were written
I think it’s much more complicated than that.
Basically here’s the situation (as far as I understand it)
Suppose that some company offers you a bond that pays 1000 dollars a year in interest for 10 years. What’s that bond worth?
If it has zero probability of default (e.g. it’s a government bond), the value of that bond is $1000 divided by 10-year treasury rate, give or take. Let’s say it’s 25k.
If some respectable credit agency tells you that the bond is AAA-rated, you might be willing to pay 20k for it.
The company takes your 20k and gives a subprime loan with 10% interest rate to someone. At 10% rate, it’s only necessary to loan 10k to generate enough revenue to pay you back. As long as home prices are rising, default rates are low, the company can spend the remaining 10k whichever way it wants (e.g. pay big dividends or do a stock buyback).
Subprime crisis hits, and now it suddenly turns out that the bond is not really AAA. (And you don’t really know what it is, because the market for those bonds is frozen solid) You do know that only 10k out of your 20k was really spent on the actual house. Besides, home prices are declining and the company will only get maybe 7-8k out of 10k if that house forecloses. Furthermore, the company will bear legal expenses and pay all sorts of fees before the house is sold, so you will only get 5k back. Finally, there is a good possibility that the company goes bankrupt and you will have to jump through all sorts of hoops before you see a singe penny.
Under these circumstances, you might consider yourself fortunate if someone agrees to buy the bond from you for 5k which is only 25% of what you paid for it.
