What happens then? FDIC has to close it, and since FDIC is underfunded, that means money comes from somewhere in the government to do it. The original bank stockholders lose, but eventually get some cents on the dollar in liquidation.
Another option is for the bank to write down the assets and then get a capital infusion from somewhere else; then the balance sheet looks better and the original stockholders are diluted. Again, the original stockholders effectively get some cents on the dollar. The source of that capital isn’t important, but in a general write-down like this, the last resort is the government. It’s very much like the FDIC taking over, except the management stays in place.
There’s nothing wrong with the stockholders getting back only pennies on the dollar, by the way; they were getting paid to take risk when they bought the stock and accepted the gains and dividends. They own part of the real estate that’s dropping in value, so they can expect to share in the loss somehow.
A third option is for the bank to foreclose on all those houses. This means they stop providing cash flow to whatever extent they were, and the bank owns a non-performing asset worth maybe 0.3 times what the face value might be. So, the bank becomes insolvent and FDIC comes in again to protect the depositors.
The point here is the money comes from the government somewhere.
The only case where money doesn’t come in from the government somehow is the case where the U.S. simply reneges on FDIC — defaults.
That possibility is thoroughly unpleasant to contemplate — unless you want to see all Treasury bond values drop to 10 cents or less on the dollar and almost all deposits disappear, making the bank crises from ’29 to ’33 look minuscule by comparison.
Ron Paul and other doctrinaire libertarians might think, “Okay, well that’s what needs to happen and the survivors will be stronger for it,” but the other 299 million people in the U.S. won’t stand for it and it would make a lot of trouble with the other six billion too.
(That’s the frustrating part about being a doctrinaire libertarian: when people are free to do what they want, they often don’t do what’s “theoretically sound.” Come up with a way to coerce them into theoretical soundness and you’ve stopped being a libertarian.)
So to a very high degree of certainty, you can figure something is going to be done, and that something is going to involve the government putting money into the mortgage business. All we’re doing now is haggling about the price.
That’s what comes of doing the sums.