Many Wall Street Firms Have Headed For The Exits
Some housing bubble news from Wall Street and Washington. The Financial Times. “H&R Block on Thursday became the latest large financial institution to be hit by the turmoil in subprime mortgages this quarter, as it served up a loss during what is normally its strongest reporting period. The company said it made a quarterly loss of $677 million on discontinued operations, which included Option One as well as writedowns, loss provisions on mortgage loans and the lower prices available for mortgages in the secondary market for mortgages.”
From Bloomberg. “Option One, based in Irvine, California, was the eighth- biggest purveyor in the U.S. last year of subprime mortgages. Such loans typically default about six times more often than conventional mortgages. H&R Block had already written down about $250 million linked to bad home loans before the sale to Cerberus was announced as U.S. defaults hit four-year highs.”
From Reuters. “H&R Block Inc. said on Thursday the unit’s net asset value fell to $1.1 billion as of April 30. That means the takeover value of the business dropped by $300 million, or 21 percent, since Block announced a deal on April 20 to sell the unit to Cerberus.”
“‘This was a really rough quarter for the subprime industry overall,’ H&R Block CEO Mark Ernst said. Ernst noted the unit’s value was written down to reflect the continued deterioration of the subprime mortgages market, where defaults among riskier home buyers have risen.”
“The fate of two troubled hedge funds managed by Bear Stearns Cos. Inc. was left in question after Merrill Lynch & Co. Inc sold off assets seized from the funds and three other banks closed out their positions with them.”
“The Bear Stearns funds once had over $20 billion of assets, but lost billions of dollars from bad bets on securities backed by subprime mortgages. Bear Stearns earlier this week proposed adding $1.5 billion of its capital to the funds as part of a broader restructuring plan, but many Wall Street firms have already headed for the exits.”
“‘The implications of that extend well outside the market into the real economy, as it would reduce liquidity for mortgages,’ said Josh Rosner, managing director of Graham Fisher & Co.”
“Merrill Lynch sold securities from the two funds in the broader markets. On Thursday, it plans to sell derivatives, a source said. Merrill Lynch did not sell all of the roughly $850 million of securities it put up for sale, a source said, but it is believed to have sold enough assets to cover its exposure to Bear Stearns.”
“Goldman Sachs Group Inc., JPMorgan Chase & Co. and Bank of America Corp. closed out their positions with the funds, which amounts to selling their positions back to the Bear funds.”
“Among the assets for sale by lenders Merrill Lynch and Deutsche Bank were investments in so-called collateralised debt obligations, or CDOs, which pool securities that can include mortgage-backed bonds.”
“One mortgage investor said that while the CDO assets for sale carried high credit ratings, they were backed by such risky mortgages as to be ‘junk in investment-grade clothing.’”
“‘The success of these auctions depends on whether there are hedge funds out there with dry powder and willing to step in,’ said one portfolio manager. ‘But the fundamentals for this market don’t look good, so either way there’s going to be some blood-letting.’”
The New York Times. “One industry executive, who asked not to be named because of the delicacy of the subject, said the banks involved in the Bear funds could collectively lose $1 billion on their lendings to the Bear funds. While the amount is not itself significant given the size of these banks, it suggests the potential for bigger losses down the road.”
“‘We have heard that lenders have already reduced the amount that they are willing to lend against C.D.O.’s,’ said Timothy Rowe, a portfolio manager at Smith Breeden Associates.”
“The two Bear Stearns funds together controlled more than $20 billion a few weeks ago and had about $9 billion in loans as of early yesterday evening in New York, the Wall Street Journal reported today, citing unnamed sources. They’d encountered resistance to a bailout plan, the newspaper reported.”
“As defaults rise, bondholders stand to lose as much as $75 billion of subprime-mortgage securities, according to an April estimate from Pacific Investment Management Co., manager of the world’s largest bond fund. Investors in all mortgage bonds will probably take about $100 billion in losses, according to a March report from Citigroup Inc. bond analysts.”
The Washington Post. “Hugh Moore, a former executive at a subprime mortgage lending company, described the situation as a ’slow train wreck.’”
“‘I wouldn’t be at all surprised if we hear about more [hedge funds] blowing up in the coming months, as the subprime market meltdown continues,’ he said. “You’ve got $250 billion of subprime [adjustable-rate mortgages] that are going to reset this year.’”
“The perceived risk of owning corporate debt rose worldwide on concern that the paralysis of two hedge funds run by Bear Stearns Cos. may cause a chain reaction that sparks losses for other hedge funds and the banks that finance them.”
“Credit-default swaps based on $10 million of debt in the CDX North America Crossover Index of 35 companies surged as much as $10,000 to a nine-month high of $179,000, according to Deutsche Bank AG.”
“MGIC Investment Corp., the largest U.S. mortgage insurer, jumped to the highest in more than two months, rising $4,500 to $84,500, according to CMA Datavision. Contracts tied to Irvine, California-based homebuilder Standard Pacific Corp. reached an 11-week high of $423,000, according to CMA Datavision. They closed at $405,000 yesterday.”
“‘While markets ignored the subprime-mania time bomb since the market shake out in March, it seems to be a longer lasting phenomenon,’ said Jochen Felsenheimer, head of credit derivatives strategy at UniCredit Group in Munich. ‘In this highly leveraged environment, when the playing field is dominated with hedge funds, the risk is you could get a domino effect. There’s the potential for more negative news.’”
“Credit-default swaps are used to bet on a company’s ability to repay debt and an increase in the cost indicates worsening perceptions of credit quality.”
“Bids for the most recent index of subprime mortgage bonds dropped to a record low for a third time this week on Thursday amid concern that losses at a Bear Stearns hedge fund indicate more widespread turmoil.”
From CNN Money. “Besides the prospect of losses piling up, there are also concerns that investors could reduce their appetite for risky bonds and loans. ‘In an environment where there are already concerns about credit and liquidity, more risky debt could be undermined,’ said Charles Diebel, an analyst at Nomura International.”
“While delinquencies on subprime mortgages are on the rise, the losses haven’t really hit full force yet on the bonds backed by those mortgages, according to Jeff Schwartz at Payden & Rygel.”
“‘Rating agencies are downgrading bonds in anticipation of the losses and hedge funds are having to look at these securities and put a value on where the market would price them right now,’ he said.”
“Last week, credit-rating agency Moody’s cut its ratings on 131 bonds backed by subprime mortgage loans because defaults on those loans were rising faster than expected.”
From CNBC. “According to Josh Rosner, Managing Director at Graham Fisher & Company, people looking to make investments leveraged to the mortgage or housing market now could find themselves catching a falling knife. He says one of the most important takeaways here could be the culpability of the ratings agencies in all this.”
“Janet Tavakoli, President of Tavakoli Structured Finance, also calls the ratings agencies to task, dubbing their recent statements to the public ‘borderline irresponsible.’ She says telling investors higher rated securities will not likely suffer loss of principal only gives them half the story.”
“The consulting firm president points out that investors in all tranches could suffer mark-to-market losses as defaults rise, even if the pools backing their own bonds don’t experience rising defaults.”
From Fitch Ratings. “Covenant protection in the U.S. leveraged loan market has declined significantly in 2007, according to a new Fitch Ratings study. This trend is occurring against a backdrop of strong and aggressive overall loan issuance in which the rating mix of new deals coming to market continues to shift toward the riskier end of the credit spectrum.”
“Through the first five months of 2007, the share of loans containing a coverage covenant of any type dropped to 44.3% from 68.1% in 2006 and below the 1996-2006 average of 78.1%, while the percentage of loans containing a leverage covenant of any type fell to 51.1%, down from 69.6% in 2006 and below the 1996-2006 average of 72.8%.”
“As covenant protections decline, the torrid pace of overall leveraged loan issuance continues. After topping $600 billion in 2006, leveraged loan issuance totaled $217 billion in Q1 2007, a 65% increase over Q1 2006.”
“Along with the general demise of covenant packages, the growth of specific ‘covenant-lite’ loan issuance has accelerated. Through May, $47 billion of covenant-lite transactions, those typically containing no financial covenants, have come to market; more than twice the level of covenant-lite issuance in all of 2006.”
“‘Demand for these loans is being driven by collateralized loan obligations (CLOs), hedge funds and other non-bank investors who continue to pump liquidity into the market,’ said William May, Senior Director, Fitch Credit Market Research. ‘These investors appear willing to absorb increasingly protection-lite deals.’”
It’s good to know the SEC is on top of things. From the WP link:
‘Securities and Exchange Commission Chairman Christopher Cox said the agency was tracking the turmoil at Bear Stearns. ‘Our concerns are with any potential systemic fallout,’ Cox told Bloomberg News in an interview yesterday. ‘So far, so good on that score.’
RE: The Washington Post. “Hugh Moore, a former executive at a subprime mortgage lending company, described the situation as a ’slow train wreck.’”
I think some of these turkeys are lifting phraseology from your blog.
Think the “slow train wreck” line’s been rollin’ around here for something like a couple years now.
You better go get a copyright and intellectual property protection
lawyer.
No problem. He’s got documented senior use on it.
So far so good? These fools are sleeping on the beach while a tsunami is thundering towards them! They are soon going to be hit by a 100 foot wave but I reckon they will tell all who will listen that it’s only a wet dream. Ladies and gentlemen it’s time to head for higher ground.
No, they will spit out the water after the first wave and call the newly damp beach bottom a permanently dry plateau.
The SEC is a joke
You mean the Southeastern Conference? Surely, not those guys who monitor the financial world? You have to be kidding!
Might as well put Spurrier & Urban Meyer in charge.
Or Meyer Lansky.
At least if you put Spurrier and Urban Meyer in charge, you would have a Winner!!!
Go Gators
Wooo Hooo! Go Gators!
Donovan would do better. He could claim, “So far, so good on that score” on one day and then on the very next day, he could flip-flop and claim that there is actually a systemic problem. He’s absolutely perfect for the SEC.
There’s nothing the SEC can do, this mess has to work itself out. So some hedge funds take some losses, so what.
The market and banks have been spreading the ARM love around.
When they have a clear idea about the risk after this it will feed back to higher risk premiums.
That will lead to much higher mortgage rates and a dearth of subprime lending.
So it could lead to a MAJOR credit contraction. Probably also hit the rating agencies pretty hard when pension funds get butchered.
So… the number of people in the market for houses will contract and prices will follow.
What? Nothing the SEC can do? That’s BS. How about throwing some traders in the clink. That would stop all the insider trading right now. Or how about becoming more strict about who can control different funds. Currently it’s just a big sell game.
How about doing anything!
The SEC is a joke
What are they supposed to do? The SEC’s purpose is to prevent traders from swindling uninformed investors (these transactions caused losses for the banks who are supposed to be the definition of informed traders) and accredited investors (who willingly forgo SEC protection by entering into a partnership agreement with the fund managers). This has very little to do with insider trading.
The SEC was established by the United States Congress in 1934 as an independent, non-partisan, quasi-judicial regulatory agency following years of depression caused by the Great Crash of 1929. The main reason for the creation of the SEC was to regulate the stock market and prevent corporate abuses relating to the offering and sale of securities and corporate reporting. The SEC was given the power to license and regulate stock exchanges. Currently, the SEC is responsible for administering six major laws that govern the securities industry. They are: the Securities Act of 1933, the Securities Exchange Act of 1934, the Trust Indenture Act of 1939, the Investment Company Act of 1940, the Investment Advisers Act of 1940 and, most recently, the Sarbanes-Oxley Act of 2002.
The Insider Trading Sanctions Act of 1984 and the Insider Trading and Securities Fraud Enforcement Act of 1988 provide for penalties for illegal insider trading to be as high as three times the profit gained or the loss avoided from the illegal trading.[10]
S.E.C. regulation FD (”Full Disclosure”) requires that if a company intentionally discloses material non-public information to one person, it must simulataneously disclose that information to the public at large. In the case of an unintentional disclosure of material non-public information to one person, the company must make a public disclosure “promptly.”[11]
Insider trading, or similar practices, are also regulated by the SEC under its rules on takeovers and tender offers under the Williams Act.
Do some research next time
And a man known for his strong moral fiber and unquestionable business ethics and strong advocacy in the rule of law, a Mr. Joseph Patrick Kennedy, SR., was the first chairman of the SEC.
Got 10% down?
The Bear Stearns funds have lost billions of dollars from bad bets on securities backed by subprime mortgages
A US corp. loses leveraged billions and it’s “so what”?
Guess I must be missin’ something here.
Hey, you make a bad investment, you lose money. What’s so hard to understand?
Hey, you make a bad investment, you lose money. What’s so hard to understand?
Nah, I think this will eventually resemble the S&L fiasco x 10.
Heads the banksters win-tails the US taxpayer loses.
They have been chatting about this over at CalculatedRisk; I have been following for the past day trying to see what affect this was going to have on the market.
Word on the street is that Merrill was only able to get rid of $100m (and that sale is not finalized yet, which is why it is not announced publically). As several posters have pointed out, there is no way they would have siezed $850m in securities if $100m was enough to cover the loss. They chickened just like JP did, but are trying to spin it so as not to spook the market.
Oh my god. They may have to switch to budget brand TP in the men’s room.
Aw, come on. How much tee-pee do men use when they…
…oh, never mind.
When they switch to the budget tee-pee in the ladies’ room, that’s when you’ll hear the howls of anguish. After all, ladies need that paper whenever they use the johnny.
Remember only one square except for those pesky incidents.
Remember only one square except for those pesky incidents
There not a square to spare!
Remember to only flush once.
I used to work for a company where they, no joke, put a sign on the stalls that said, “one flush only”.
This was during the dot com boom and I guess they were trying to save some money.
“They chickened just like JP did, but are trying to spin it so as not to spook the market.”
The emperor has no clothes. In the end, this was nothing but a giant Ponzi scheme of sorts.
They chickened just like JP did, but are trying to spin it so as not to spook the market.
First, I take umbrage at the misuse of my name. I am not chicken!
Second (and on a more relevant note), I think you are exactly right. The poor bastards seized $800M before realizing the actual value of the assets, and are now stuck with a choice: Sell them and realize their own loss, or wait for a miracle to occur.
This situation is quite analogous to the Internet startup meltdown. VCs had lots of junk that had yet to be revalued. They get paid as a proportion of managed assets. So they delayed marking their portfolio companies down for as long as possible.
For the case of Internet startups, it took about 3 years from the peak until most of the portfolios were honest again. The question here is whether the hedgies are as adept at delaying revaluation as the VCs were.
FYI: Congressman asks SEC to delay Blackstone IPO. That’s gotta hurt.
http://tinyurl.com/2nyy87
Good catch.
From Reuters.
NEW YORK, June 21 (Reuters) - Merrill Lynch & Co. (MER.N: Quote, Profile , Research) sold only $100 million of the $850 million in collateralized debt obligation bonds it seized from troubled hedge funds of Bear Stearns & Co. (BSC.N: Quote, Profile , Research), a person familiar with the auction said on Thursday.
The sale of the CDOs late on Wednesday was one of several planned by Wall Street banks trying to extricate themselves from the funds managed by Bear Stearns’ asset management unit. The Bear Stearns funds have lost billions of dollars from bad bets on securities backed by subprime mortgages, which in recent years have become the main ingredient in many CDOs.
Merrill Lynch spokesmen were not immediately available for comment.
A reprint of a comment I made elsewhere (but is still highly relevant):
Afriend of mine laid out some connections which I find fascinating. First, the Bear Stearns auction of the Merrill CDOs has been continued today. Remember how they initially seized $400 million of CDO obligations, then it went up to $800, then $850m? Well, today Duetsche Bank got into the fray and added another $350m of CDOs it seized and is auctioning, so there’s over $1bn of CDOs up for grabs. Now the auction is continuing. How many reasons are there for that? One. They can’t get the price they want. The rumors in the currency trading circles are that the auction was also continued so the big lenders have time to position themselves with options on the downside of xx vs. yen pairs because (and here’s the great part) the big houses need to unwind the carry trade *right now* to have liquid funds available for margin and leverage calls when it becomes apparent that over $1 trillion of CDOs being held are worth considerably less than face value. Think it through slowly, because it’s huge. I can barely grasp the full extent of this process, so maybe we call in the black-belts to handle this one.
Update: Bloomberg reports that Merrill has pulled the plug on the auction after selling only a “small portion” of the CDOs. http://www.bloomberg.com/apps/news?pid=20601103&sid=aKayDn8BDFB8&refer=news
Apparently they either could not get the price or the howls of protest have penetrated - or both. Now to see if Deutsche Bank follows suit…
Holeee TKO-CDO, Batman!
Is it possible no one bid on it at all? They have a solid record of losing $billions with it before. Sign me up for that anvil!
KIA,
is there a timeline on when they have to mark to market these CDOs that they seized from BS,or can they hold them in a sort of limbo?
No idea. I suspect it’s dependent on the terms of the financing agreements, so only an insider could say for certain.
Thanks for the answer.
A billion dollars is not that much money. If everyone is freaking out that the revaluation will zap-fry investments worth many times that amount, why wouldn’t they just bid the market value most convenient for them? Take the loss and unwind discreetly.
In fact, why wouldn’t all the bids at the auction be driven more by that mentality than by a market valuation?
It’s not the initial billion which is a problem. It’s the leverage on that billion of another ten billion, and the leverage which was piled on top of that as well. Everything has been so leveraged, cross-leveraged, tranched, collateralized, and bought on margins that a drop in the initial billion could collapse a pyramid of two, possible three magnitudes of order larger.
I have some fall puts, just waiting to add some more.
tx, what specific puts do you have, and what are you waiting for? I bought a ton of Jan 08s and 09s in Feb/March (WM, CFC, TMA, IMH, BAC, FMT) and lost about half of my total investment before bailing out in disgust last month. I only have the IMH and BAC ones left and they’re just about flat. CFC really killed me. Only my SRS has done decently but it’s “only” a 14% return so far. I got greedy with the option plays, hoping for a quick double (or worst case some positive movement) but instead saw my Roth IRA go from 25k to 12k in double quick time. Of course, many of the puts recovered after I sold them!
“We’re not surprised to find the principal circle of players is pretty interconnected,”
The “usual suspects”!
It’s simple math. BSC hedge fund is leveraged at least 6x. At the height the fund was worth $20b. So equity is around $3.5b
Last week they dumped $3.8b worth of the AAA tranches. Then the value of the fund was reported at $9b. What’s left is the AA, A and equity tranches. The equity tranch is worth zero. It absorbs loses first and kicked off the debacle. So the AA & A tranches are worth book value of $9b.
The three largest creditors SEIZED (read: all they could find) $850, 500, 150 million of CDOs respectively. But we already know that they extended $ 16b in credit to the hedge fund to buy CDOs. Therefore the loss on the CDO’s is in the neighborhood of $13.5b.
Obviously when 50 subprime lenders go belly up. The mortgages they wrote must also decrease in value. But since the financial system decided to bury their collective heads in the sand no CDO portfolios were adjusted. Now the adjustment will be breath taking.
More importantly the CDS holders are going to pull a margin call. By not adjusting the CDO portfolios the holders (investment banks) were collecting payments from the credit default swap (CDS) holders. Now the CDS holders are going to force the CDOs to market prices to get that premium back and more.
Pucker up Bernakae
Could get really interesting. With the ratings debacle, the MBSs and their derivates might become unsaleable so that mortgages will get ’stuck’ with lenders. Under these conditions, it might be tempting for servicer/guarantors (i.e. Countrywide) to just default, if the cost of covering lost principal from foreclosures exceeds the revenue from the servicing business. A single default, and the whole mess will unravel. Would that be the end of the beginning, or the beginning of the end?
BTW, bondholders will not in general be able to sue servicers- bondholders have a contractual agreement with the securitizer, who often is not the servicer/guarantor. I am not really sure what sort of leverage even the securitizer will have if the servicer defaults (even after trying to read some ’sales and service’ contracts).
Maybe their “$850 million” is only selling for $100 million.
I think it more likely that there is a high degree of cherry-picking going on as the would-be purchasers finally start scrutinizing which loan packages might generate some kind of positive return versus which loan packages are sheer toxic waste which is guaranteed to suffer further losses. The percentages revealed by this auction should be a five-alarm warning for the industry.
“Option One, based in Irvine, California, was the eighth- biggest purveyor in the U.S. last year of subprime mortgages. Such loans typically default about six times more often than conventional mortgages. H&R Block had already written down about $250 million linked to bad home loans before the sale to Cerberus was announced as U.S. defaults hit four-year highs.”
Here’s the monster that bought it…
http://www.amosink.com/Publication/Cerberus.jpg
http://en.wikipedia.org/wiki/Cerberus
“In Greek mythology, Cerberus or Kerberos (Greek Κέρβερος, Kerberos, “demon of the pit”) was the hound of Hades, a monstrous three-headed dog (sometimes said to have 50 or 100 heads).”
They just took Chrysler off Mercedes’ hands, too. Cerberus CEO Dr. Evil could not be reached for comment.
Ex Treasury Secretary John Snow is one of the folks now at Cerberus. I don’t remember what his title is, but it is interesting how the game works.
Remember Phil Gramm at where was it, UBS?
a close friend of mine works at cerberus
and lives way high on the hog
no problem for the big dogs
btw the ceo of cerberus lives in a modest house and drives a years old pick up fwiw
So is Mr. Potatoe, Dan Quayle
Maybe Cerberus is funded by the US gov, or the Chinese.
Think Blackstone.
The Chinese wants to sell cars here, so buying Chrysler makes sense.
Cerberus has bought left and right, it seems. Where does Cerberus get its money from? Rich Americans? China? Other foreigners? Leverage?
They get their money from mostly rich Americans and probably institutions (private equity firms play pretty close to the chest with their investor list). Cerebus is big and fairly famous so they shouldn’t have had any problem raising funds in the environment of the last 3 years. Then they lever their capital probably 3-4x for a buyout. So with probably 10-40b in active funds (my guess), they could make buyouts of 40-150 billion. Goldman, KKR, and Blackstone are all in that league.
“one of the most important takeaways here could be the culpability of the ratings agencies in all this.”
Interesting housing bubble parallel between ratings agencies and real estate appraisers, IMHO. I just love the blame game and all the finger pointing. The truth is, everything has been so gamed, so blurred, so submerged, nobody knows WTF, anywhere.
A little sunshine is the best disinfectant.
Why all the handwringing? The quants and black boxes had this all covered.
This is how these people can pay $73M for a painting. Money is like water to them. Easy come, easy go.
Bet the next time that painting is sold, a hefty loss is taken.
There’s little doubt that the honest quants probably told their bosses that what the model says is only as good as the assumptions and they wouldn’t buy it. If you plug in the last 4 years of default losses (in a huge rising valuation bubble) of course the losses will appear tiny and the computation say “lever up boys!”. And the quants know that doing something like that is bogus, but if it is useful for their salesmen……
The only quant computation the top cares about is the two and twenty. They make money on the upside, somebody else gets stuffed on the downside. Any quant simulation shows that in such a payoff function you go for broke on the leverage until the investors spaz. In an illiquid market with subjective valuations (sound familiar?) that can go on for a long time.
This is the wall street version of zero down flippers. If they catch the upside they win big, if they lose, well there’s always foreclosure and bankruptcy.
Except the managers won’t be bankrupt, they’ll just be unemployed for the down cycle.
Some of the smart ones may have put away their stash in zero-beta t-bills.
“This is the wall street version of zero down flippers. If they catch the upside they win big, if they lose, well there’s always foreclosure and bankruptcy.”
Great parallel, just like RE Appraisers = Ratings Agencies.
Wall Street meets Main Street.
Value of CDO = Value of RE
Not quite true.
The CDO is similar to a secured Corporate bond, however most buyers are counting on the interest income. When housing is liquidated in foreclosure the funds go the the holders of the CDO. If 80% of all subprime and Alt A mortgages go into default, there are still 20% paying their mortgage either in full through a refinance or as agreed in the mortgage note. If in foreclosure the house sells for 50% of CDO valuation the CDO gets those funds. These determine the present value of the CDO. Obviously if one could steal a CDO at 10% of original vvalue, it would be the trade of the decade. Correspondingly, if one could sell the CDO at 70% of original value, it may be considered the sale of the decade. The biggest determinant in present valuation of a CDO is the number of non performance and anticipated short term future non performance. It is merely an interest play on a ‘C’ grade bond.
“When housing is liquidated in foreclosure the funds go the the holders of the CDO.”
Yes, well, good luck with that. Lessee, now, we got 20% of Mr. Jones, 30% of Mr. Gomez, 60% of Mr. Lifschitz, aw, heck, anyone for a game of Paper, Rock, Scissors?
RE Appraisers = Ratings Agencies.
LMFAO…Given the functionally illiterate rabble licensed by the state real estate appraisal boards after 1993, it’s no wonder there’s a full fookin’ meltdown.
Be careful with confusing CDOs and REMICs. A CDO often is similar to a closed-end bond fund (called a static CDO)- a manager ‘collects’ asset based securities (debt) and then makes them saleable by tranching them. All of the instruments in the CDO could be cr@p- depends on the CDO. (Incidentally, the contracts governing CDOs are often dozens of pages long- what a nightmare to comprehend.)
Now, a mortgage pool can be purchased and made into a REMIC/MBS by tranching, also. In this case, if the underlying mortgages are subprimes, you get a series of tranches (bonds) with ratings AAA (often 2/3 to 80% of the principal), AA, etc and one or more mezzanine and equity (the worse) tranches that are held by the securitizer to ‘insure’ and protect the higher tranches. Defaults (of servicers), excess foreclosures, inflation risk hit these in the expected ways, as is much discussed here. CDOs are a whole ‘nother layer of complexity- a CDO might be based entirely on BBB tranches from REMICs, or even on OTHER CDOs (this is called a CDO-squared). A CDO based on BBB tranches could easily be completely vaporized by a rising foreclosure rate. Without knowing the mix of debt instruments that collateralize the CDO, it is impossible to guess how unstable these are. For exactly that reason, I would guess that they will tend to be full of cr@p.
Of course. My comments were entirely sarcastic.
Gimme mine, who cares about the rest . . . . Until they have to sit in a deposition and splain what they did and why.
As it was put to me once, “For as long as there are investors, they have a free, in the money, call on the investors money.”
Interest rates up… but stocks up too. Why the sudden disconnect today?
Call it the Blackstone Bump. 17 IB’s involved, can’t bring that pig out on a down note.
Sweatin’ to the Oldies.
No confidence. By definition, fiat currency is only as valuable as the confidence in it. Put away your charts, muzzle your Kudlows and Cramers. All you need to know, in the end, is there’s no confidence. The damage is done. RIP Bubble.
Agree. The confidence in the bond markets is eroding rapidly.
Can someone answer this question for me in layman’s terms: who is it at Merrill Lynch that is going to be hurt by this and how much? Is it the stockholders of Merrill Lynch? Is it the investor/clients? Is it the management?
My understanding….
The entire financial system is based on a CDO being worth what is owed to it. John Q Public deposits $250K with a hedge fund. Joe Schmoe borrowed $250K to buy a house, that loan was packaged into a CDO for $250K, then bought by the hedge fund with the investors money….
Then, the $250K CDO is used as colatteral to borrow $2.5 million to buy more CDOs containing mortgages made to 10 more Joe Schmoes. This way, a 1% move in the market means the initial hedge fund investors make 10% on their money.
Repeat…. until there is over $1 trillion in CDOs used as colatteral for loans to buy the CDOs.
well, let’s say a few of the Schmoes start defaulting on their loans. No big deal. Foreclose and sell for $250K to cover the debt…. OOOPS!!!!! That $250K house that Schmoe bought, can’t be sold for $200K.
So, those CDOs start to drop in value just a touch. Suddenly, the 1% move = 10% ROI turns around. 1% drop = 10% loss. 10% drop =…
Well, when the hedge fund borrowed the money to buy the CDOs, there was an agreement to hold a certain value in assets. As the accets drop, margain calls means you have to sell the assets to repay your loans… it all unravels.
Well, if Merril sells the Bear Stearns CDOs for far less than “book”, suddenly everyone has to revalue, and all have margin calls which means they have to repay their loans, which means more CDOs sell at lower price, meaning more revalues and more margin calls and more liquidations.
In short, the whole financial system based on leverage (using a small amount of money as collateral to borrow a lot) unwinds.
Think 1929.
This is why I think that the Fed (or the PPT if you will) will intervene here.
This IS systemic risk. There is no question. All of the “big boys” are heavily leveraged here, including the investment banks and the regular banks. This is why the President’s Working group on Financial Markets exists.
Imagine Bank Of America failing. (they’re one of the people in this mess).
The Fed will engineer a bailout. It will be secret handshakes, long term orchestrated plan, just like LTCM. All behind the scenes (it has to be to allow the orchestrated trades to work, and to keep confidence in the financial markets)
The fed has much more weaponry than just liquidity (although they may use some of that too). They also have a lot of POWER.
They can sit all the involved parties down, and tell them exactly when and how all parties will trade. They will then quietly inject needed liquidity to make that plan happen (if necessary- they may be able to do it without added liquidity, who knows).
If the parties refuse: they are jettisoned from the Fed’s protection. *(and will perish)
They will thus comply, they always have in the past. They always will.
You will see some big losses, no doubt. However those losses will be at key times to ensure survival of the firms. When done, the secret handshake will be honored and all firms will be restored to their prior glory, PLUS compensation for cooperation.
Merrill thought they were hedged. I’m sure that Bernanke and Paulson (or perhaps Greenspan even?) have now met with Merrill and shown them the true state of how things will be. Either that, or they looked through their books and realized that selling those CDOs would be cutting off the face to spite the nose.
we’ll sadly NEVER know what’s really going on the last few days in Manhattan. So sad…
an example of “cooperate and live” was the Continental Illinois National Bank and Trust which went bankrupt.
It was saved (on the surface) by the FDIC, but the FDIC didn’t have enough cash to save Continental. Thus, the Fed orchestrated a govt bailout of Continental… saving the bank. (and it only took many billions of dollars of taxpayer money to do it).
Later on after countless taxpayer infused dollars, the bank was sold at a HUGE discount to Bank Of America!!!
I wonder why we used FDIC money to repay NON-FDIC accounts at a bank? Or to repay bondholders or stockholders??? (since those accounts shouldn’t have been paid?)
it’s called long term cooperation. take the hit early, get the rewards later.
it’ll happen again.
HIC, you are right, but I feel sick to my stomach, I really do.
I support Ron Paul’s bill to abolish the FED. For health reasons. They make me sick.
Yeah, let’s use newly printed money to bail out the Wall Street heavies. Imagine if they didn’t get their $200M bonuses next December?
I just called my representative to voice my support for HR 2755, Ron Paul’s bill to abolish the FED.
“…the Fed orchestrated a govt bailout of Continental… saving the bank. (and it only took many billions of dollars of taxpayer money to do it)….”
After the Fed stepped in, 90 day certificates of deposit were yielding 0.5% more than a US Tbill WITH THE SAME GUARANTEE! It was an incredible arbitrage - I hope it happens again…:>)
I bet a billion CDOs that Mr Bernanke has not been sleeping well this week and that some shotgun weddings are going on in Wall Street.
You lost me at the first sentence.
Merrill Lynch may be hurt in the Bear Stearns fiasco in several ways. The most obvious is they loaned moneys to Bear Stearns that may not be payed back. (This will come out of Merrill’s earnings statement). Merrill can also be hurt by having the same CDO in their portfolio and having to adjust their margin accordingly. From accounting they can defer this as interest lost and not have to report on the quarterly statemnet. Third, Merrill could be in the same positions as Bear Stearns and be forced to liquidate (this does not appear likely at this time). For Merrill’s quarterly statements appear to show that the firm was engaged in CDOs for its own behalf.
Residential mortgage loans
Mar 30 2007 $ 41.559B Mar 30 2006 $ 19.705B
a 22B increase in residential loans.
Merrill’s 10Q
http://tinyurl.com/2c9b8x
There is one other way that all would be hurt.
This small event triggers a liquidity bust which in turn causes the derivative products to “dry up”, this results in a world wide financial crisis.
Possible, yes; probable, I do not know.
And who’s to say that $250k note is securing by a $200k property, but rather one thats loaded with incurable physical depreciation; sits in a slum; and is now only worth site value less cost to demolish.
Of course the above situation was aided and abetted by a crooked apprisal process.
Think of those NJ gutted multi-’s in that Sopranos episode that were mortgaged to HUD for $400k, and were nothing but worthless shell with all the interiors stripped out.
Lottsa that shit out there.
These MBS chucks ain’t got a clue as to what they’re holding.
“Think 1929.”
Nah. Unfortunately, the FED and/or PPT or WTF have taken all the fun out of it. No leapers, no brains on the boardroom wall.
Da Boyz are shovelling so many therapy mints (pharmacueticals) into their maws they don’t feel a thing.
There’s something to be said for a little guilt and shame.
The stockholders first. (Or maybe, the secretaries first, then the stockholders.)
He says one of the most important takeaways here could be the culpability of the ratings agencies in all this.”
Chanos has another winnah here!
Search for the guilty is full-on.
Boy, who would have ever thought that the ratings agencies were corrupt?!
‘”These investors appear willing to absorb increasingly protection-lite deals.’”
translation:
These investors seem to not care about getting screwed.
Translation:
If you’re ubber rich, you’re set.
If you’re poor, govt. takes care of you.
If you’re anywhere in the middle, govt. will drain all your assets from you until you are poor, then the govt. will take care of you.
Remember the old version of the game of life? Whoever finishes with the most money wins… unless you are sure you are not going to finish with the most. In that case, you place ALL your assets on a single spin of the wheel. If you hit your 1 in 10 number, you win!!! if you hit the 90% lose everything, oh well, you were not going to win anyway.
Well….. that’s life.
We’re not going to win based on our paychecks. May as well gather all the assets we can, then use those assets for a 1-in-10 chance of hitting it big!
Same with the game Monopoly. When I was young, we used to build houses on our properties very slowly, only when we had the csh to cover landing on other’s properties.
As I got older, I discovered the way to win. AS SOON as you get a monopoly, mortgage every other property you have to put hotels on your monopoly as quickly as possible…. hope somone lands on your hotels before you land on theirs.
Playing it safe is the way to lose.
As I got older, I discovered the way to win. AS SOON as you get a monopoly, mortgage every other property you have to put hotels on your monopoly as quickly as possible…. hope somone lands on your hotels before you land on theirs.
Playing it safe is the way to lose.
LMAO…
Yeah go tell it to the thousands of those middle section investors players lookin’ at low to mid six-figure losses, which the big guys WILL chase them down for like the hounds of hell.
Nothin’ like that slow trickle of nervous sweat runnin’ down the small of your back when those certified mail envelopes start arrivin’.
“Yeah go tell it to the thousands of those middle section investors players lookin’ at low to mid six-figure losses, which the big guys WILL chase them down for like the hounds of hell.”
Testify, Brothah! I know it is not funny, but you just created an image in my mind that has me in fits of laughter. I can’t help it. Here’s the kicker: no more equity in the homestead to cover margin calls. Ouchie!
“Yeah go tell it to the thousands of those middle section investors players lookin’ at low to mid six-figure losses, which the big guys WILL chase them down for like the hounds of hell.”
My future sis-in-law/bro-in-law, that make $60K per year combined, but owe $250K on a house they bought 5 years ago for $140K, that are sitting at 8% with an ARM that will go to 12% 1.5 years from now, that went bankrupt 2 years ago… If there is sweat running down their backs, then they need a trip to Orlando to help wipe it away.
They’re planning their trip to Disneyworld for Sept.
then they need a trip to Orlando to help wipe it away.
Denial is the American way.
Yeah,
I’ve noticed the value of work continues to be marginalized over time. So much so that the benfit of working is not worth the time invested. Better to cheat and game the system. You will at least have time to enjoy life and family.
Testify, Brothah James. What good is a mansion if all the toilets back up and no one wants to show up to fix them? What good is a Rolls if the mechanics couldn’t be bothered?
More like less human value in the work done. Hard to feel invested in a keyboard - as opposed to the land you and your family has worked for years. Maybe a part of your observation is that we have reached an end to consolidation, and now no one cares about an honest day’d work anymore. They about the paycheck, but not the work.
I’ve invested in a keyboard…MANY keyboards here!
“If you’re anywhere in the middle, govt. will drain all your assets from you until you are poor, then the govt. will take care of you.”
If…it were only that simple. That’s where the North American Union comes in - the gov’t isn’t going to be taking care of anyone’s poor once the pan-american labor pool is cemented. Hilly will happily finish the job the good old boys (GOP) started - believe it. The script is written, its all over but the gnashing of teeth….unless free thinking comes back into vogue - ha!
Philly fed reports strenthening activity. Generally, is keep reading mixed economic news, good in some ways bad in others, good in some places bad in others.
Only one trends is moving the same way everywhere all the time — mortgage deliquencieis and foreclosures. And with all those resets, two more years of this are in the bag.
“trends is moving the same way everywhere all the time — mortgage deliquencieis and foreclosures.”
And inventory of houses for sale, and drops in sales, and falling prices….
Merril may be able to liquidate Bear CDOs without making the price public, delaying when everyone has to revalue their CDOs…. but delaying the revalue will not change the fact that more is owed on houses than what those houses can be sold for, and lots of those houses are going to get foreclosed and cause mass losses.
Unravel now or unravel later… but falling housing prices will make it all unravel.
Just before Ben’s CNN Money post above is a short paragraph with a separate link (to Reuters). The full piece asserts that ABX-HE BBB- 07-1 was bid down to about 59. Does this basically mean 59 cents on each dollar of underlying debt? or is that interpretation too simple-minded? Thanks txchick or whoever knows.
I thought that ABX BBB- was up in the 90s or so just before the subprime meltdown…some drop! (I’m too lazy to go look it up, It’s a nice day outside, and I’m getting myself some sunshine!)
AZ, yes I believe you are correct. This index is off the high risk tranch of all the loans. Probably the top 3% of the loan pool. So $100 loan, this is the high risk $3 that takes the first loss. And now it is worth 59% of the original par value. It will go much much lower if large numbers of home loans default and the foreclosed assets do not bring full loan value at sale. I would think the BBB- tranch could easily get wiped out completely.
I am guessing that the BBB tranche is high risk, but it is not the equity tranche (i.e. highest risk) as the securitizing company usually keeps the highest risk tranches themselves. Probably BBB is the highest risk tranche that is put on the market. Maybe it is the [3%,10%] or something like that. Though I agree that the BBB tranches for subprime are going to be wiped out completely. These might be unsalable now.
I also made a theoretical link between ABX and the value of the underlying asset–the houses. Because the owner of the security actually owns a piece of the house, the market apparently believes the value of the homes are only worth 59% of the appraised value. If they didn’t, they would simply foreclose and sell the house.
I also believe that the bid on ABX BBB- is also a valid indicator for how far house prices are going to fall in general (beyond just the houses that are packaged in the bond). I think this because any given neighborhood probably has loans ranging from subprime to prime. And where go one set of comps, all valuations must go. It’s not like subprime was just used in the ghetto.
That means the takeover value of the business dropped by $300 million, or 21 percent, since Block announced a deal on April 20 to sell the unit to Cerberus. “This was a really rough quarter for the subprime industry overall,” H&R Block Chief Executive Mark Ernst said.
…You can almost hear him think: “Glad it’s over!”
Is this the tipping point??
If Wall St. starts to back away from the MBS shit, lenders can’t sell off their loans. And they can’t afford to lend to a bunch of crappy credit risks.
Neil may be right. Hefty downpayments may be here sooner than we think, which will absolutely tank the market.
Well, at least it’s nice to see that the major bagholders in all of this are rich hedge fund guys, because in the past we were worried about simple money market accounts or other low risk investment funds being affected. Of course, this is not over yet.
This very well could be the tipping point.
Up to now, folks could keep their head in the sand about the values of their MBS holdings. Now if there is simply no liquidity for these things, the value HAS to be impaired…
“If Wall St. starts to back away from the MBS shit, lenders can’t sell off their loans. And they can’t afford to lend to a bunch of crappy credit risks. ”
Banks who keep their mortgages instead of selling them are much more conservative. In Alaska, the banks that did not securitize their mortgages survived the real estate collapse of the mid 80s exactly because they played it really safe.
I think that the mortgage pools will end up being sold back to the lenders (due to knowledge asymmetry, they are the ones most likely to be able to evalute them) for 5 - 40 cents on the dollar. Only the SEC could look with equanimity at the collapse of a $100 billion PER QUARTER MBS market…
“One mortgage investor said that while the CDO assets for sale carried high credit ratings, they were backed by such risky mortgages as to be ‘junk in investment-grade clothing.’”
BWAH-HA-HA-HA-HA! Investors are JUST NOW coming to this realization!
Nice to have liquidity drying up even more, just when RE ‘professionals’ are declaring that we are “at the bottom”.
Where, oh where, has my spring selling season gone, or where oh where can it beeeeeee…
Howcome everything seems to be hitting the fan, and on CNBC they keep saying like every 15-20 minutes that the subprime mess is “contained”? Reminds me of the US description of the Soviet Union, as it continued to spread control around the world.
Is it me, or is Kudlow an idiot?
“NEW YORK (CNNMoney.com) — More than $1 trillion worth of adjustable rate mortgages (ARMs) will be hit with higher reset rates this year, and that could add up to big trouble for many homeowners.
Already, the rate of serious delinquencies among subprime hybrid ARM borrowers was up to 15.75 percent during the first quarter, from 14.44 percent in the fourth quarter of 2006, according to the Mortgage Bankers Association (MBA).”
($1 trillion = $1.000.0000.000.000) / $300.000 (est. financing per house) * 15% (est. rate of serious delinquencies) = 500.000 homes, that are flooding the market this year
“More than $1 trillion worth of adjustable rate mortgages (ARMs) will be hit with higher reset rates this year, and that could add up to big trouble for many homeowners.”
Bachman Turner Overdrive: “You Ain’t Seen Nuthin’ Yet”. (sheesh, am I pegging my age, or what?)
middle boomer?
Couldn’t the fed create a phantom hedge fund that would purchase all the dead bodies and just get rid of them. Since hedge funds are private no one would ever see their books. Just a thought.
LOL! Imagine the havoc WE (the people) could really create if everyone en masse stopped paying mortgages, car payments, credit cards, student loans, etc. Jebus! Our little way of “sticking it to the man”.
They’d stick you back. Do you get paid in cash or gold? If you think your “paycheck” would be worth anything in this scenario think again.
Big P~
That post about the guy with the inherited jewelry store was mint!
“Couldn’t the fed create a phantom hedge fund that would purchase all the dead bodies and just get rid of them. ”
At around $400 billion a year in new CDO/MBS issues and more than a trillion in outstanding CDO, might be a tad hard to buy them all up. The printing presses might overheat…
I think it was Tyler Derdan that wanted to set it back to $0 in “Fight Club”. Project Mayhem!
OT:
Time to Give Up the House?
“A new study finds that, in a shift from the past, subprime borrowers are paying their credit cards before their mortgages”
“For generations, homebuyers have had one simple rule drilled into their heads: Whatever happens, keep paying the mortgage. If you don’t, you risk losing your house and all the equity you’ve built up in it.
“But for many subprime borrowers, that doesn’t seem to be the rule of thumb anymore. They are now more likely to be late on their mortgage than on their credit card, according to a new study from Experian Group, the Ireland-based company that maintains a huge database of consumer credit histories.”
This is going to get ugly…
I agree, look at this from the same article:
“At the same time, keeping access to their credit cards has become more important than ever, says Stan Oliai, vice-president of decision sciences for Experian Decision Analytics. “People are using credit cards for everyday items like gasoline and groceries, and to tide themselves over from paycheck to paycheck,” says Oliai.”
Doesn’t their cc company have a surprise waiting for them? What happens if you default on your mortgage, doesn’t your cc rate go up to 20%++? I assume these people carry a balance on their cc’s…
Subprime borrowers may realize that they have a lot more leeway to be late on mortgage payments. The very earliest that foreclosure can occur, in certain states, is four months. It typically takes six months to a year, and in some places it can take over two years, notes Duncan.
2 years of free living…Best keep the Kohls & Wal-Mart card clean
so you can charge more junk for the spoiled brats.
Exactly, besides maintaining one’s consumer credit mobility is all important to participate in this society.
Perhaps one day, in some cruddy apartment or trailer, they’ll tell the grandkiddies how they lived in a “house” once upon a time.
Miss a credit card payment and there are HUGE penalties and a much higher interest rate. If you have a balance on a credit card that is x.x% until paid off, they can’t even change your rate if you default on your home. But be a day late on a single payment on that card, and your rate tripples or quadrouples or worse!
I think that “covenant lite (”cov lite”) will become one of the acronyms, or an adjective thereof, of the historic CDO debacle that is now unfolding. I think it’s great that we, thanks to Ben Jones and his blog, have been able to watch this sucker hatch from just its caviar state. It’s like a financial “Living Planet.” While reasonably well-educated, as are virtually all of our posters, I never before have been able to sit ring-side to watch the unfolding of a major economic event as I have been privileged to, here. Thanks, Ben, and to the posters who contribute so many useful insights and links.