An Open-Ended Black Hole
Some housing bubble news from Wall Street and Washington. The Orange County Register. “In another fallout from Orange County’s subprime mortgage industry collapse, Brookstreet Securities Corp., an Irvine broker dealer, shut its doors and laid off 100 local employees because it could not meet margin calls on complex securities backed by faltering mortgages, company spokeswoman Julie Mains said.”
“The securities, known as collateralized mortgage obligations, lost value as Wall Street confidence in mortgage-backed securities collapsed. Mains said the value of Brookstreet’s securities plunged to 18 cents on the dollar, forcing the company to dip into its capital to meet margin calls, which is when investors must increase deposits to meet minimum account requirements.”
“‘It wasn’t a problem with securities,’ she said. ‘It was a problem with the margins.’”
“Stuart Meissner, a New York attorney and former securities regulator, said he received calls from people whose Brookstreet accounts went from $250,000 to negative value. ‘They were supposedly guaranteed 10 percent returns,’ Meissner said.”
The LA Times. “One Brookstreet broker, who declined to be identified, attributed Brookstreet’s troubles to a bond division at the firm that had set up a special website for wealthy investors. The broker said the site allowed investors to purchase collateralized mortgage obligations with as little as 10% down and the other 90% borrowed, rather than the 50% down that is typically required on such margin accounts.”
“A combination of rising longer-term interest rates and defaults on sub-prime mortgages caused the mortgage bonds to lose value, losses that were greatly magnified because of the heavy borrowing that funded the purchases, the broker said.”
“In some cases this would more than wipe out an investor’s entire position overnight, putting the burden on Brookstreet to make up any amounts owed to the National Financial unit of Fidelity Investments, which held the accounts.”
“In the end, National Financial began selling the assets of investors as their accounts declined, leaving them, like Brookstreet itself, with huge losses, the broker said.”
“‘Disaster, the firm may be forced to close,’ Stanley Brooks said in his e-mail to brokers Wednesday. ‘Today, the pricing system used by National Financial has reduced values in all collateralized mortgage obligations. Many of those accounts were on margin and have suffered horrendous markdowns.’”
From Bloomberg. “Losses in the U.S. mortgage market may be the ‘tip of the iceberg’ as borrowers fail to keep up with rising payments on billions worth of adjustable-rate loans in coming months, Bank of America Corp. analysts said.”
“‘The large volume of subprime ARMs scheduled to reset at higher rates in ‘07 and ‘08 will pressure already stretched borrowers,’ forcing more loans into foreclosure, the Bank of America analysts wrote from New York. A collapse of the Bear Stearns funds ‘could be the tipping point of a broader fallout from subprime mortgage credit deterioration,’ they said.”
“Countrywide Financial Corp. and IndyMac Bancorp Inc., two of the largest U.S. home lenders, may suffer more than other finance companies because they hold mortgages themselves as well as selling them on to investors, the analysts wrote. They may not have set aside enough money to cover losses, said Bank of America.”
“Bear Stearns Cos. is proposing a bailout of a money-losing hedge fund by taking on $3.2 billion of loans to forestall creditors from seizing assets, the biggest rescue since 1998, people with knowledge of the plan said.”
“Bear Stearns, the second-biggest underwriter of mortgage bonds, increased efforts to salvage the fund, one of two that made bad bets on collateralized-debt obligations.”
“‘The problem is not what we see happening, but what we don’t see,’ said Joseph Mason, associate professor of finance at Drexel University in Philadelphia and co-author of an 84-page study this year on the CDO market. ‘We don’t know the price of these assets. We don’t know which banks are exposed to this sector. These conditions are the classic conditions for financial crises across history.’”
“The first CDOs were created at now-defunct Drexel Burnham Lambert Inc. in 1987. Sales reached $503 billion in 2006, a fivefold increase in three years. More than half of those issued last year contained mortgages made to people with poor credit, little loan history, or high debt, according to Moody’s Investors Service.”
“CDOs may have lost as much as $25 billion because of subprime defaults, Lehman Brothers analysts estimated in April.”
“Bear Stearns’s proposal doesn’t involve taking equity. Instead, the firm would become a lender to the fund, its loan secured by the assets of the fund.”
The Street.com. “Some question the New York investment bank’s effort to salvage the failing funds. ‘The investor in Bear Stearns’ stock is faced with the fact that the company may be lending money at below the rate it earns on capital into an entity where there is nogood way to determinate value of its assets,’ commented Richard Bove, analyst at Punk Ziegel.”
“‘It is also important to understand that $3.2 billion, if this is the right number, is 24.8% of Bear Stearns’ common equity,’ he warns.”
“The sale of the fund’s holdings could cause a significant repricing in the overall market because it will give an indication of where to value these hard-to-parse securities. A repricing is a scary notion because subprime has been a mess for investors, and the value of debt with subprime mortgage ties is much lower than it was several months ago.”
From Reuters. “U.S. credit derivative indexes reached their widest levels since February on Friday on continuing concerns about possible contagion arising from an auction of some troubled mortgage assets.” ”
“The index of high volatility credits, which comprises mainly ‘BBB’-rated swaps, widened one and a half basis points to 97.5 basis points and the index of crossover credits reached an all-time wide of 170 basis points, three basis points wider on the day, according to a trader.”
“Losses at hedge funds managed by Bear Stearns have brought together two of investors’ biggest fears in a nasty confluence of risk. First, there is the spectre of hedge fund failure, renewing long-held worries about systemic risks to global assets. Second, there is the threat of a credit market meltdown.”
“The nature of the investments at issue, collateralised debt obligations (CDOs) which, in this case, contain at least some subprime mortgages, are more worrisome. ‘Hedge fund losses are a minor concern compared to the broader economic damage that would result from an open auction of subprime CDOs,’ Peter Schiff, president of Euro Pacific Capital, said in a note.”
“A rising of credit costs would come as major central banks are generally tightening monetary policy and global bond yields are rising.”
“A major concern from any melt-down would be not just the rise in risks and losses in assets but the potential for a banking crisis as banks were left holding bad debt. The Bears Stearns case after all, does involve at least five of the world’s leading financial institutions.”
“The market has absorbed sales without incident, but lenders to hedge funds may still be hurt as they’re forced to remark positions, said said Christopher Sullivan, chief investment officer at the United Nations Federal Credit Union.”
“A benchmark subprime mortgage bond index fell to record lows this week, putting bond traders on edge about the prospects for spillover to other credit markets. The so-called ‘home equity asset-backed securities’ are backed by bundles of loans to homeowners with the riskiest credit.”
“‘The market is really worried about a contagion,’ said Michael Metz, chief investment strategist at Oppenheimer & Co. ‘It’s an open-ended black hole, and a lot of people are going to take to the sidelines until it’s clarified. Nobody knows how serious it is going to get.’”
“‘The problem is that marking down the assets to where the market will bid them may in fact be the right thing to do, but no one wants to take the loss,’ said Jason Brady, who helps manage $4 billion in bonds at Thornburg Investment Management.”
“Some of the assets also include so-called CDO squared structures, which are CDOs of CDOs and even more difficult to value.”
“‘They only want to sell the higher-quality assets,” said Mirko Mikelic, a senior portfolio manager who oversees $5 billion in fixed-income assets for Fifth Third Asset Management. ‘Right now there’s no trading going on for lower-rated securities.’”
From MarketWatch. “For the second time in a week, the Federal Reserve was urged to draw up tough rules to stem abuses in the mortgage industry on Thursday.”
“Meeting at the Fed’s headquarters, members of the central bank’s consumer advisory council urged regulators to use their legal authority to stiffen regulations about the affordability of subprime loans, to improve disclosure about risky loans and apply anti-abuse rules to as many lenders as possible.”
“One action the Fed is reviewing is whether to write a rule about lending only to borrowers with proven ability to repay their loans. Edward Sivak, director of policy and evaluation for Jackson, Miss.-based Enterprise Corporation of the Delta, urged such a rule.”
“‘We’re living in the unintended consequence right now,’ he said.”
“The problems in the subprime mortgage market aren’t yet well enough understood for regulators to propose a quick solution, said Cleveland Federal Reserve Bank President Sandra Pianalto.”
“They are complicated by the speed and breadth of financial innovations, Pianalto told a community development conference in Cleveland, and ‘I am convinced that there is no single solution or ’silver bullet’ that will cure them.’”
“Pianalto said financial innovation had driven down costs for borrowers and provided a wider range of credit choices, but had also brought an increasing number of new players into the mortgage market, from brokers and underwriters to servicers and rating agencies, that at times have conflicting incentives.”
“‘For example, because a mortgage broker is typically compensated only when a loan is made, he has an incentive to approve the loan. However, this incentive may conflict with the interest of the potential borrower,’ she said.”
This will make you laugh or cry, depending on your prediliction:
Minyanville’s daily Five Things You Need to Know to stay ahead of the pack on Wall Street:
1. Who’s Buying Subprime Now?
As problems at two Bear Stearns hedge funds have Wall Street mortgage desks scrambling to offload subprime debt to bids as low as 30 cents on the dollar, the question now is who is buying what they’re selling? Why, the usual suspects of course: university endowments. Seriously.
According to the Wall Street Journal, university endowments are stepping up as buyers of subprime debt.
“There’s an opportunity out there to buy these loans at a discount,” Lou Morrell, vice president for investments and treasurer at Wake Forest University told the Journal.
Wake Forest’s $1.2 billion endowment is in the process of placing about $25 million with a hedge fund to invest in subprime mortgages, the newspaper reported.
Because subprime loans could sell for steep discounts, “they will be popular with a lot of endowments out there,” Morrell said.
Wake Forest isn’t alone. Vanderbilt University has earmarked $50 million to invest in debt backed by subprime mortgages.
Bill Spitz, chief investment officer for the $3.4 billion endowment at Vanderbilt, says he has no expertise in the mortgage market, but is placing money with a new fund from Trust Company of the West as part of Vanderbilt’s strategy of putting as much as 5% of the fund’s assets into “opportunistic” investments they hope can boost returns, the Journal said.
2. S&P Delinquently Considers Delinquency
Delinquency rates for residential real estate loans are considered “low by historical standards” by most housing boom apologists. According to data from the Federal Reserve, delinquency rates at all banks on residential real estate loans are barely at 2%. But here’s the catch: what exactly IS a delinquent loan?
According to the Fed, delinquent loans are those past due thirty days or more and still accruing interest as well as those in nonaccrual status.
However, the problem is delinquencies - low “by historical standards” but running at their highest rate since 2002 (you know, 2002, the good old days of what the Fed feared would be a deflationary collapse) and as of first quarter data just posted their largest year-over-year surge ever - are very likely dramatically underreported.
Why? Because lenders have many incentives to modify loan terms to help borrowers avoid default or delinquency.
These days lenders are doing everything from changing the terms of mortgages to lengthen the maturity and lower the payments, to forgiving payments outright for a period, to decreasing the interest rates.
That’s all well and good… unless the models for pricing mortgages rely on delinquency rates and defaults to help establish risk parameters… as we are now discovering.
Now, Under proposed new rules, S&P said it may change its debt rating criteria on home-mortgage bonds and begin classifying loans as delinquent or in default when their terms are changed to be more favorable to borrowers.
Bloomberg.
Delinquency or loss rates are tracked as part of so-called triggers in the securities that control the amount of protection investors in the securities receive, the article explained.
And as we now know, excluding a loan with changed terms from delinquency or loss rates may mislead investors on the performance of the security.
In other words, objects in mirror may be closer than they appear.
Check out these two quotes.
“Losses in the U.S. mortgage market may be the ‘tip of the iceberg’ as borrowers fail to keep up with rising payments on billions worth of adjustable-rate loans in coming months, Bank of America Corp. analysts said.”
June 20 (Bloomberg) — The worst U.S. housing slump in 16 years will begin to ease in the next month or two, and job growth will lift home prices and spur construction early next year, Bank of America Corp. Chief Executive Officer Kenneth Lewis said.
Hey, the CEO of B of A and the analysts are saying two completely different things. Maybe their email system is down. What a bunch of fcuk-ups.
Perhaps this is similar to what was going on at Merrill from about nine months to 18 months ago.
If I recall, Rosenberg was saying “lookout” to investors because he was concerned about an MEW contraction and residential housing slowdown-led recession being on the horizon. Meanwhile, ML units went out and bought and/or made deals with subprime lenders.
It’s always interesting when internal strategy ignores what company analysts are telling clients.
As txchic said in another thread (I believe), the former (analysts) have a legal obligation to clients, whereas the bankers are just being Pig Men in a world awash in liquidity.
[Many thanks to Alan Greenspan and the "Do Nothing" Fed!]
Ken Lewis is lending credence to the Peter Principle.
As long as the schools are private I don’t care. Maybe if the endowment melts down they will start letting regular people go to school there because they need the money.
Many already do. Seriously.
Why? Because lenders have many incentives to modify loan terms to help borrowers avoid default or delinquency.
And you know who is the Great Doer of these good deeds? EMC Mortgage.
And you know who owns EMC? Guess.
I’m not sure whether I should be happy or sad that I guessed right. Perhaps, scared would be most appropriate.
Yesterday I posted a semi-rhetorical question about whether my securities are safe in the custody of Merrill Lynch. If not there, where? Let’s just say, better ML than BS.
a rolling loan gathers no loss
Laugh - it’s making me laugh.
Perhaps this was posted yesterday, but more from Minyanville:
“How Could This Happen?
‘Traders and industry executives who saw lists of C.D.O.’s on offer from the Bear Stearns funds say that even as the manager of the funds, Ralph Cioffi, bought some protection against a deteriorating housing market, on balance his investments seem to be based on a belief that the subprime market would not crumble, or at least not soon,’ the New York Times reported this morning (6/21/07).
Now, that raises the following question: How would a smart hedge fund manager arrive at the belief that the subprime market would not crumble?
Probably by listening to the following experts:
- March 28, 2007: Federal Reserve Chairman Ben Bernanke said, ‘At this juncture … the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.’
- March 29, 2007: Treasury Secretary Henry Paulson said he thinks the economic damage from the subprime lending crisis is ‘contained.’
- April 4, 2007: Federal Reserve Bank of Dallas President Richard Fisher said damage from the U.S. subprime mortgage market is ‘mostly contained.’
- April 11, 2007: The subprime mortgage market is ‘little more than an asterisk in the overall U.S. credit economy,’ said Roth Capital Partners economist Donald Straszheim.
- June 12, 2007: Lehman Brothers Chief Financial Officer Chris O’Meara said Tuesday he remains confident that weakness in the nation’s subprime mortgages is waning.”
http://www.minyanville.com/articles/index.php?a=13172
Are you kidding me? Though even I could recognize this as tripe, a professional hedge fund manager couldn’t? Unreal.
perhaps you haven’t taken my advice and read “fooled by randomness”?
Maybe these guys should start taking out Sound Bite insurance. Anytime they make an incorrect bet based on believing a sound bite and lose money, the insurance pays off.
jawboning the subprime meltdown….
lets hope it works with inlfation
ROLMFAO!!!! Read between the lines. Where is the popcorn guy, Imm’a need a 55 gallon drum.
“securities plunged to 18 cents on the dollar”
“accounts went from $250,000 to negative value……were supposedly guaranteed 10 percent returns”
“could be the tipping point of a broader fallout”
“bailout….$3.2 billion….is 24.8% of Bear Stearns’ common equity”
“cause a significant repricing….scary notion”
“open-ended black hole…Nobody knows how serious it is going to get.”
“no one wants to take the loss”
“Fed is reviewing”
“unintended consequence….aren’t yet well enough understood”
And Rome burned while the Fed fiddled!
Yes Rich and how about this one…
“…the broker said the site allowed investors to purchase collateralized mortgage obligations with as little as 10% down and the other 90% borrowed, rather than the 50% down that is typically required on such margin accounts.”
That is one to laugh about: Alt-A loans to buy bonds backed by sub prime mortgages. This house of cards is getting weaker all the time and I feel a stiff breeze starting to build.
“Bill Spitz, chief investment officer for the $3.4 billion endowment at Vanderbilt, says he has no expertise in the mortgage market, but…”
nuff said
Notably absent from the endowments noted is….Yale, Harvard, Stanford. Had they been investors, they would have been commented on. They are probably as far away from these mortgages as possible.
Most Americans don’t have the faintest clue how stinking-to-heaven a scam the financial markets are. It’s all rigged and covered with lies from thin air.
If the endowments grow and grow and grow, shouldn’t the cost of education at these schools be dropping, instead of increasing?
The interesting thing is that as endowments are growing and growing, debt is largely keeping pace at all but the richest universities. Colleges and universities are spending money to lure premier researchers, build new research facilities, new stadiums, new rec centers and unions to recruit students, etc… I think most folks would be very surprised to hear just how leveraged many institutions have become–public and private.
Anyone glad they’re not a Bear Stearns shareholder. They’re living up to their acronym - “BS”
bsc off less than 1% on a
Suggested name change - “Pig Stearns”
With where this is headed, I think “Bare Sterns” is more apt. (and yes, “Sterns” and not “Stearns” is intentional)
Remember March 1 when a BS analyst recommended New Century. These people are totally corrupt.
‘BS analyst’
Y’mean B(ull) S(teaming pile of crude)?
Good one.
I like that. Will email all my friends about Bare Sterns.
“‘We’re living in the unintended consequence right now,’ he said.”
That’s what Matt Leinhart says every morning when he looks at his baby.
“The problems in the subprime mortgage market aren’t yet well enough understood for regulators to propose a quick solution, said Cleveland Federal Reserve Bank President Sandra Pianalto.”
Hey, Ms. Fed Reserve Chair, you might have checked Ben’s Blog for the last 12 to 18 months and gained enogh education and insight to know exactly what the consequences were and are.
Another “Murphy’s Law” winner getting promoted with the right credentials and lack of brain width
I’m not sure there is anything the FED or congress could have done with “regulations” once the greed and lies snowballed out of control. Every regulation and warning was just another excuse for a new form of deception. The only thing the FED could have and should of done, was raise the freakin’ interest rates early and often. May Alan Greenspan go down in history as the worm and egomaniac that he is.
Ah, but he doesn’t care. After all, the British knighted him for his great work — he is now “Sir” Alan of Greenspan.
Actually not possible - you have to be UK born to be knighted.
They have special awards they can give to non-UK people, but “Sir” is strictly for Brits.
Kinda like not being able to be President if you weren’t born in the USA.
“Actually not possible - you have to be UK born to be knighted.”
Apparently not - Sir John Templeton.
My bad - you do have to be a UK Citizen, as was John Templeton, when he was kighted.
What about Bono?
A market based on a foundation of ponzi finance will collapse just as surely as the ponzi scheme that supports it.
The only solution is to let the ponzi scheme break (which it is), fix it, through more reasonable lending practices (verifying income and repayment ability, anyone?) and let the MBS market rebuild itself based on more sound fundamentals.
And let those that took the financial risk bear the losses and do what you can to mitigate risks to the now fundamentally sound basis for the industry…
In other words, balance job loss with inflation…which is what I think the Fed is trying to do…
The real challenge is trying to deal with massive job losses that could ensue because of the collapse of the ponzi based system…that’s the struggle.
It’s a quagmire. That is the problem with government, school boards, the military, big companies. They becomes so inundated in beauracracy that faster nimbler foes can run circles around them without so much waste.
“Losses at hedge funds managed by Bear Stearns have brought together two of investors’ biggest fears in a nasty confluence of risk. First, there is the spectre of hedge fund failure, renewing long-held worries about systemic risks to global assets.
What would a summer or fall market day be without one of these. Last year it was Amaranth, my guess is the next one will be some fund with a insufficiently hedged China bet.
IMHO it will be some innocuous transaction involving a major US Corporation that defaults on its debt. According to S & P ratings 75% of America’s S& P 1000 credit is junk bond status. If for example GM were to default on its 30B debts there are 300B in derivatives written against the debt that would also go into default. (GM is an example not meaning to imply their debt is faulty.)
“‘It wasn’t a problem with securities,’ she said. ‘It was a problem with the margins.’”
Actually it was mark to market. Someone got scared about holding your overpriced, illiquid CDOs as loan collateral and called their loans in. Game over, man…game over.
“Brookstreet managed $571.6 million in 3,644 accounts”
“Mains said the value of Brookstreet’s securities plunged to 18 cents on the dollar, ”
Let’s do the math…. $468.7 million dollar in wealth creation… I mean negative wealth creation.
How many of those customers have loans with those accounts as colatteral, and now face margin calls of their own?
The “FUNNY thing about leverage is when you loose control or it slips. it can take your head OFF.
Welcome to the Sleepy Hollow Squadron GAMBLERS !
“How many of those customers have loans with those accounts as colatteral, and now face margin calls of their own?”
Great question, IMO.
“‘It wasn’t a problem with securities,’ she said. ‘It was a problem with the margins.’”
At 18 cents on the buck, I’d say there’s a problem with the securities.
Nah, its never “their fault” — its either the media, the banks, or someone else who suddenly lost faith in their ponzi scheme and created a panic. Remember Enron: “It was just an old fashion run on the bank!”
“In the end, National Financial began selling the assets of investors as their accounts declined, leaving them, like Brookstreet itself, with huge losses, the broker said.”
Investors wiped out. Brookstreet wiped out. Therefore National Financial also took a loss. Who else, how many, and what next? If nothing else, there is a lot of “creative destruction” going on.
I’ve said it before and I will say it again; mark to market and let’s crash this pig.
Look at National Financials financial statement. $10 billion in securities owed by clients. They can scratch 5% of that today. Fidelity will not be happy. Glad I closed my FSHBX two months ago. 35% MBS/CDO junk. and a .5% fee to boot. I went to Vanguard. .1% fee and 100% T’s.
I’m also a happy Vanguard camper.
VGPMX?
This 1000 lb financial REIC HOG in lipstick has been flying high with it’s tiny 2 inch wings for 5 years. It’s about time that it saw a MIRROR.
LOL!
Agree…
leverage. works well when it works.
slaughters you when it doesn’t.
What the hell were those guys thinking? Allowing leverage at such high levels?
oh well, pigs get slaughtered.
this is all big for mass psychology. It’s been a few days since I’ve seen the “subprime is contained” bull.
With leverage, you can lift the world, or be crushed by it…
“Stuart Meissner, a New York attorney and former securities regulator, said he received calls from people whose Brookstreet accounts went from $250,000 to negative value. ‘They were supposedly guaranteed 10 percent returns,’ Meissner said.”
A fool and his money are soon parted…..
“The broker said the site allowed investors to purchase collateralized mortgage obligations with as little as 10% down and the other 90% borrowed, rather than the 50% down that is typically required on such margin accounts.”
A fool and his money is right. They were done in by their own greed. Didn’t these buffoons ever hear “if it sounds too good to be true, it probably is”? How about a new term, FI? It stands for effed investor.
“if it sounds too good to be true, it probably is”
But, it was guaranteed!!!
It’s different this time! Can’t happen here!
The guarantee is only as good as the guarantor.
This is one of the most screwed up things I’ve read on this blog to date. Let’s see….
Investors were buying CDOs of subprime loans (think loans to strawberry pickers living in $500k homes bought with no money down — 100% financing) with 90% borrowed money. Along the way, the builder pulled out its profit, the Realtors® pulled our their 6%, the mortgage broker pulled out their cut, the mortgage underwriter took their cut (before selling the CDO).
I’ve worked in corporate finance for the last 15% and have seen some pretty screwed up things (especially in the Dot.com days). However, this is way worse than anything I’ve seen.
This is going to get really ugly, really quickly.
I guess I don’t understand something here. What we’re talking about is mortgages, packaged up nicely and sold as investments, right? Seems to me that is the cost of those mortgages dropped to 18% of initial value unless the value of the houses they represent also fell to 18% of initial value, there should be some worth greater than 18%. What I mean is that the homes may be really worht 50% (or something) of their mortaged value, but the value of the mortgages fell to 18%. Wouldn’t that mean that even in the worst case, total default on all the paper, there would still be recoverable value there? Am I missing something?
Not when you buy the CDOs on margin.
Let’s say you “invest” $1M to buy $2M worth of CDOs (50% of your investment on margin). Then, the $2M of CDOs suddenly drop in value by 41% and become worth $1.18M. Since you’re still obligated to repay the $1M margin, now your $1M suddenly becomes worth $0.18M when you liquidate.
That’s how you can $1M into $0.18M (18% of intial investment) even though the underlying assets are still worth 59% of their original value.
I apologize in advance for the long post.
What you need to consider is that this is not buying one loan at a time, it’s buying pools of loans, or more accurately, parts of loan pools.
Say the there are $100 in loans have an average interest rate of 9%. There is $9 (plus amortized principal) per year to pay lenders/investors.
You break the pool of loans into two pieces (tranches):
You tell the first group of loan buyers that for $80, they can buy the most secure 80% of the portfolio. In other words, 20% of the principal in the pool needs to be wiped out before they are touched. Moody’s looks at the structure of the proposed pool, runs some numbers, and calls this tranche AAA rated. It’s very safe. What are the odds that 20% of the loan pool is wiped out? Small enough to declare the first $80 of principal safe as can be.
For this AAA rated piece, the investors are willing to accept a 6% interest rate. Of the $9, they get 6%, or $4.80 (6% of $80).
So, there is $4.20 left to pay the rest of the schmucks/investors.
The next investor buys the remaining $20 and is told he is in the first risk position (takes the first losses), and gets $4 per year, a 20% return for the risk. This buyer is essentially using the leverage of the first tranche investors to boost his returns.
$0.20 goes to the servicer to manage this whole thing.
It can get much more complicated (like selling $100 in loans for more than $100).
So, with a 5% principal loss in the pool, the buyer of the second tranche loses 25% of his principal if the rest of the loans pay off (he gets interest too though, so he may be OK).
But, we’re not talking about how much principal has been lost, we’re talking about how much principal is expected to be lost, and thus the return that others expect to receive if they were to buy the note. Since when you borrow money on margin to buy the asset, the ultimate performance of the asset is less relevant than the marked to market value–how safe is the lender if they need to take the assets and sell them on the open market? Can they be made whole? Can Merrill Lynch be made whole by seizing and selling the Bear Stearns CDOs that were collateral for Merrill’s loans?
Let’s say no principal has been lost yet, but people expect some more principal to be lost–in the market, they expect to earn not 20% anymore for that risky piece, but 40%. They are not willing to buy the $20 piece for $20, they are willing to pay only $10 ($4 equals 40% of $10). The investor if they need to sell loses 50% of their principal with a change in perception only.
If they don’t need to sell, they grit their teeth and pray that perception is worse than reality.
But, if they borrowed money on margin to buy the tranche…MARGIN CALL!!! Sell the asset for $10 and get the hell out!!!
If everyone was buying single loans with buyers who put 20% down, and not splitting them up and levering them, you would be dead on right, you can only get hammered 80% as a lender if the home drops 100% in value. But when you use leverage (in buying the riskier tranches) on top of leverage (levering the money of people buying the AAA pieces) on top of leverage (people borrowing 100% to buy homes), you have a far more dangerous financial setup.
It’s in the process of toppling over. I fear things will unravel quickly from here.
nice post, thanks
Best explanation yet I’ve seen of CDOs and tranches.
The old adage still applies… a sanded, buffed, lacquered, polished, and spit-shined to a chrome-like finish turd is still a turd.
Who lent 90% to these investors leveraging CDOs? Is it the Chinese? They have liquidity flowing out of every one of their pores.
The concept is too funny, they borrowed money (and lots of it) to lend to a strawberry picker. LOL.
The suit in the Hamptons wouldn’t have anything to do with the Encino, CA strawberry picker, but dress it up in a CDO with lipstick and they’re great pals.
I’m trying to imagine this transaction in the real world face to face. My gut hurts.
Reminds me of the Seinfeld episode where George comes up with the idea for a sitcom where the situation is he gets in an accident or something and can’t pay so the court sentences him to be the plaintiff’s butler. Maybe the same thing can happen here. We’ll see new Bear Sterns commercials for equities that look like that commercial “You, the right computer.” And they’re each wearing a shit that says “You”, “PC”, and it has a guy that joins their hands. Only in this case it can be “Investor”, “Personal debt serf”.
negative value?
What the heck?
Invest $5 million, and control $50 million in CDOs. A 1% increase in the CDO gets you a 10% RoI….
An 11% drop in CDO gets your $5 million wiped out, and you get sent a bill for another $500K.
And you try to sell your house for $500k, and, uh-oh, there are no buyers out there.
Bravo! This is the simplest description I’ve ever read!!!
The fool and his money were lucky to get together in the first place.
Must be trust fund babies.
richistanis
Trustafarians.
Has anyone read Richistan (the new book) yet? If so, what did you think of it?
I could barely hold my breakfast down just looking at the cover.
Trust fund babies - we call them lucky sperm club around here.
Probably not trust funds per se. Trustees are constrained by a “prudent man” rule that usually keeps them in common stock, Treasury bonds, maybe high-grade corporates and high-grade munis.
I’m telling you it’s CONTAINED, the subpriome mess is CONTAINED! Just say it over and over again until you feel warm and fuzzy.
The tsunami is contained - with pieces of plasterboard.
Oh yeah, that’s what Larry Kudlow told me.
ex-nnvmtgbrkr,
I keep saying that..”it’s contained, it’s contained, it’s contained” just like you said…munch, munch, munch…but it sounds really weird with a mouth full of “Neil’s Buttered Popcorn”…it sounds more like…”beer at Hooter’s…beer at Hooter’s”
Damn, maybe my hearing is really starting to go…munch, munch, munch…
The subprime meltdown is “Contained” in a riddle, wrapped in a mystery, inside an enigma.
“Bear Stearns Cos. is proposing a bailout of a money-losing hedge fund by taking on $3.2 billion of loans to forestall creditors from seizing assets, the biggest rescue since 1998 . . . ”
This is called professional falling knife catching, we know what we are doing . . . do not try this at home!!!
The other fund Started out with $5.5 billion in assets. When the forced sale started, the better assets were going for close to $.90 on the dollar… or so leaked reports indicate. That liquidated about $2 billion. Then prices started to drop and Bear stepped in and offered a $1.5 billion rescue. No thanks, and sell off continued as they sold off $2 billion more in assets. That is “book value”, not sale price as no one is sure what the sale price was.
Then Merril stepped in and siezed $850 million if the $1.5 billion-ish left and tried to sell that… Bear offered another bailout, but not enough. Rumor is Merril is looking at getting maybe $.60 on the dollar.
Now, the $400K or so of what is left.. the truely toxic stuff, the highly leveraged CDOs of CDOs, may be worth as little as $.10 on the dollar.
Wealth creation……
Get $500 million in investors’ cash, use that as collateral to borrow $5 billion at 5% and then loan the $5 billion at 8% to FBs that buy $150K houses for $250K.
All is fine if you can sell that house for $250K when the FB defaults. Ooops… That $250K house is only worth $150K. Ooops, our $5 billion in CDOs are only worth “a lot less” but we’re way too afraid to think about just how much les….
So, they have to sell bonds at 6% to pay back the loans that we took out. AND hope they don’t get killed too quickly by the foreclosures.
Foreclosure rate isn’t “yet” that high. The rate of foreclosure isn’t killing the system. It is that the houses can’t be sold for close the amount needed to cover the loans. The crashing housing property values is what is killing the system for now. It really gets rolling when the foreclosure rate soars and the loss on each one gets larger and larger.
Basically, these securities can not be sold. There are only a few firms that would take them - the largest IBs - and then we’re probably looking at (a guess) 30% below the 30% below where they are marked (the latter being what some are calling the true value). The market for these securities is so thin that if BS unwinds it is probably looking at prices that make effective yields go from 8 or 9% to 18 or 20% (again, just a guess). ASo it says, what the hey, if we sell we’re out over half our principal in one fell swoop so why not try to prop it?
Repeat: there is NO market for these securities.
This is why Michaal Milken was so valuable….without him the Junk Bonds crashed….He MADE the market for them.
Today we have nobody in charge.
TRUE!
we’re out over half our principal
[replying to self] and that’s not even taking into account leverage. If the leverage really is 10-1, it would seem there is no way this fund can be solvent - roughly a 1-2% increase in yield (100-200 bp) translates into a 10% price drop, depending on duration. Hell, the market (what there is of it) probably moved that much in today’s session.
Wonder if they are using collateral of the firm itself and not just the fund in the highly-leveraged borrowings. If they weren’t, why prop it up? Hmm. Gotta be a Financial Times, NYT, or WSJ story on this this weekend that paints a bleaker picture than the “not a disaster” being heard today.
Sounds like the only market is the mother ship of Bear Stearns. Are they putting money into the fund to redeem unhappy investors? To satisfy the lenders that there is enough equity in the fund?
I’m assuming that at some point, they would be better off to redeem investors at some discount for illiquity and take their risk on the CDOs for the next number of years. It only makes sense to prop up the value of these things for so long.
Or a fool and his money is some party!! Makes you wonder about these folks, not much sense, but lots of money, how do they do it?
To quote Jim Carroll “…Though they do get good drugs, and they do give good head.”
Damn I guess people when they see me know i don’t have a drug connection so why hire me.
I predict some very nice boats around here will on sale for drastically reduced prices, got popcorn?
It’s too bad the timing is not right for me to finally get that 50′ Grand Banks trawler I’ve always wanted.
I’m waiting for a Donzi.
Wonder if any of them will be retitled from BS owners to ML owners.
The question is, will anyone take the first loss piece? And if no one will, can you securitize mortgages?
A residential mortgage holder only loses if both the borrower and the value of the property go under. We are definately looking at 20% down, with a hard look at real comps AND real income.
don’t forget, I think we also might see a return of the appropriate risk premium.
people will start to see that MBS are NOT as “safe” as Treasurys and will price them accordingly.
Got 7.5-8% mortgages?
I think it depends entirely on the underwriting proposed.
I was just thinking that I would be interested in taking a first loss position IF, and only IF the properties were in specific markets, 25-30% equity or greater, and no more than 25% of the borrower’s income was to be used toward the mortgage.
In those cases, I’d bet that the risk/reward is going to be pretty attractive for those first loss pieces. We may not have overshot the bottom in values for these tranches yet, but NO ONE being willing to buy them at all is a pretty good indicator that there could be some opportunity there…
Personally, I’d LOVE to see 20% down come back into style. That alone would be a great price-pounder.
That would definitely bring back **true** affordability (as opposed to “affordability products” which have the opposite effect.
Bring on the 20% down payments!
Somebody musta be watching the “Collaterized Debt Obligations” (does that not just slide off the tongue) fandango today……market is down around 150 and three hours to go.
PPT boys will be in about 3 o’clock to pump it right back up right as rain.
Purchasing CDO’s on margin? How damn inventive is that???
We can’t build crap in this country anymore but we damn sure know how to part fools from their money in a highly effective manor!
manor=manner
Sorry, NYC public school rears it’s ugly head again
Actually, “manor” was pretty funny, given the context.
it’s=its
Lots and lots of iceberg analogies being used in reference to sub prime and also home foreclosures, I wonder next December if we will be hearing “like the survivors of the Titanic we are flailing around in the freezing water with little hope and minutes to live.”
As anyone told you that you can’t read the last chapter of the book first.
Try reading a book in Japan, start from back to forward. =)
It does take a while to get the hang of Manga. Even if the English translation is bound of the left and the pages go from left to right, the panels within a page go from right to left.
“A combination of rising longer-term interest rates and defaults on sub-prime mortgages caused the mortgage bonds to lose value, losses that were greatly magnified because of the heavy borrowing that funded the purchases, the broker said.”
Dot Com The Sequel. The greed. The leverage.The denial that this beast could just keep going.
Even the MSM is using the phrase “tipping point.” Which probably means it’s already happened.
You forgot the fraud also. They will march out some sacrificial lambs soon enough to be put in jail, and then have blustery speeches about turning the industry around and legislation.
not quite sacrifical lambs, because the ones they choose fo slaughter will be guilty as hell too…
that said, there will be scapegoats. They’ll deserve their punishment, but they’ll take the blame and punishment for countless others.
Sort of like scape-Jesuses, who will go to jail for the entire industry’s sins. It already makes me mad seeing some lower rung upper manager paraded through a big trial, as the CEOs of Bear and Merrill and Goldman walk off with billions.
Toxic waste:
http://www.safehaven.com/article-7812.htm
From that:
“But with its concentration of risk, the equity slice has been hemorrhaging value. No-one is bidding. But that’s not the full extent of the problem. There are so many similar hedge fund loans backed by questionable and illiquid securities at marked-up prices - untested by dealing on the open market - that the lending banks have stopped trying to sell for fear it will accelerate and exacerbate the problem into a full-grown systemic disaster, forcing every similar hedge fund out there to own up, catastrophically, to significant overvaluations in their CDO equity portfolios, too.
There is currently no market for this toxic waste. Everyone is taking a breather. All this came to light Thursday - and amazingly the US stock market went up. But it really could turn very nasty. Everyone with a hedge fund holding in any similar market is powerfully motivated to sell today.
What people don’t fully appreciate is the extent to which our financial system has geared up over the last twenty years to finance the worldwide residential housing boom. Banks used to have to work quite hard finding profitable businesses to put their money into. But for twenty years now, those banks which concentrated on financing housing have left everyone else in their wake.”
*******
The money quote:
“What people don’t fully appreciate is the extent to which our financial system has geared up over the last twenty years to finance the worldwide residential housing boom.”
Geared up?
What will happen when it gears down? As it is doing now…
Redline, if the vehicle is well maintained maybe nothing else.
If there is deferred maintenance, redline, smoke, thunk, blown engine.
How much Zantac do you think is being consumed on Wall Street right now?
Buy Now..they aren’t making anymore TOXIC WASTE.
Yeah..Right !
“They were supposedly guaranteed 10 percent returns,’ Meissner said.”
Sorry there are no guarantees when you gamble, not at the horse racing track, not at Vegas and not on Wall Street. However if you go to the horse track, you at least are guaranteed to watch the pretty horsees run around and if you go to Vegas you might get to watch other pretty fillies, while on Wall Street all you get to see is some guys in suits
This article is a classic example of Wall Street Gangsters strike again.
This is all too reminiscent of the Enron collapse. A trading system is created based on future earnings, those earings are trumped up to bring in more investors, speculation gets out of control and the whole thing collapses because it’s based on the “idea” of furture earnings.
My thoughts exactly. How quickly we forget. And we keep doing it (and allowing it) over and over again.
BTW, OT, and most of you probably saw this, but if you haven’t seen “Enron, smartest guys in the room” it is a definite renter. Wow. scary stuff. This is America.
Is that the same version as shown on PBS recently? Done by Bethany McLean and Peter Elkind? Very well done. I kept wanting to turn it off and go to bed but I couldn’t look away.
That movie made me want to go Medieval. Like postal, but worse…
If you haven’t already, read “Extraordinary Popular Delusions and the Madness of Crowds.” Fundamentally, this bubble is no different from the South Sea Bubble, the Tulip Bubble or any other speculative bubble.
We spend a lot of time on this blog talking about the influence of the Fed, etc. , but fundamentally, those mechanisms are just enablers. Speculative bubbles are a manifestation of mass psychology, and if even without an “easy money supply” from the Fed, it would still have found some way to happen. As long as human beings (1) conduct transactions based on fear and greed and (2) allow their better judgement to be swayed by conventional “wisdom” there will always be bubbles, and in 20/20 hindsight, they will all look alike.
But we TRY as some level to creat markets that are less suceptable to manias, and more difficult for shady types to take advantage of manias to fleece others. The transparancy and trading rules are designed to make stocks in publicly traded companies more difficult to pump and dump. etc. Inevitably, when big money is being made, people chafe at the restrictions that are designed to protect them.
Some people try to. Others argue that a market completely free of any kinds of restrictions would price risks perfectly all the time, and that bubbles are created by government policies.
Personally, I’m more inclined to go with the mass psychology explanation. I think bubbles are inevitable (subject to conditions 1 & 2), and the best we can do is try to limit their repercussions on “things that really matter” by regulation.
Everything is based on future earnings. That’s where NPV comes from. That’s why a borrower’s debt is considered a bank’s asset.
It’s interesting that everyone is focused on sub-prime and Alt-A. My guess is that there are potential problems with some prime loans, especially those whch are HELOCed to death and where employment of the borrower is in jeopardy.
Quite. Normally housing declines when a recession impacts employment and some people can’t keep up their payments. However, this time around housing is declining before the recession starts. As the economy slips into recession, the normal recesion-driven problems will compound the pre-existing problems. Maybe not the “perfect storm,” but a pretty good one nonetheless.
A lot of this is a bit over my head, but when I read a line like this, I know that people were going completely insane. They traded CDOs as speculative investments, not even worrying about how much they were actually worth based on the actual interest owed. It’s the same detachment from fundamentals that drove the housing market. Someone else will pay more for your debt than I did. Better buy it! With borrowed money! Good God.
“Some of the assets also include so-called CDO squared structures, which are CDOs of CDOs and even more difficult to value.”
I’m not sure how inappropriate that is … If you look at the “big picture”, the money people make in trading comes out of the pockets of other traders, not out of the asset that is being traded. Of course, people tend to assume that this money is ultimately based on the value of the asset, but it wouldn’t be the first time that this assumption was wrong…
The trading costs are typically embedded into the product one way or another. Trading costs ultimately are paid for by consumers or “investers” which is a fancy word for a consumer who had money left over.
Ooops. I should’ve been clearer. By “trader” I meant both the actual trader as well as the investor.
The distinction I was drawing was that the money made by trading in the market actually originates from other participants in the market – not from the underlying asset. In that respect it is not necessary for the price of an asset to reflect the fundamental “worth” of the asset.
High risk investments allowed at only a 10% down ,subject to a margin call . Inability to rate these high risk securities .
Loan down payment loans at zero down for unqualified buyers .
Didn’t we learn the lesson by the 1929 stock market crash that you can’t allow this sort of leveraged buying based on a market going up ?
Low down payment loans - not loan down payment loans -Sorry
Loan downpayment works too… Borrow $40K at 10% and use it as the downpayment for $160K at 6%. This is the classic 80-20 piggyback. When it defaults, the holder of the $40K gets hurt hard, but they knew that, which is why they wanted 10%. The holder of the $160K is just fine, which is why they only got 6%.
Oh… wait…. what if the house sells after foreclosure for less than $160K……
Pop goes the bubble.
John Succo
Jun 22, 2007 2:01 pm
The subprime mortgage pools are a symptom of a much much larger credit boom that has infected the entire credit spectrum, low quality to high.
Professor Succo and Reamer,
I discussed your article with a hedge fund manager who, in turn, discussed it with a Wall Street type who, as he says, “drinks the cool aid.” I thought that you would find his “riskless” answer interesting…
The fact that his guy is using the ABX HE (a synthetic) to suggest bond funds are mis-marking their portfolio is absurd. He never tells you that the ABX HE is NOT the cash market where bonds are actually traded. The cash market will NOT wait for the rating agencies, I assure you. And, he only shows you the BBB- traunch. He also only uses the 2007 vintage. >90% of all sub prime RMBS are A or higher. Intellectually, not very honest research.
I have zero residential exposure long. So I have no beef here. This dude is heavily short the ABX HE 2007 BBB- and is trying to push research supporting his position. I happen to agree with his position except that it’s very crowded and risky now. Subprime is mess. But it’s a mile deep and a half inch wide. If you want to pour short capital into the singular ABX HE 2—7 BBB - you have lots of company.
Also remember that “HE” stands for Home Equity. These are “zero down” mimics. They reflect 90% of all sub prime RMBS are A or higher,” this is entirely true, but again, irrelevant. According to Moody’s (they are using the 2006 issuance for mortgages but the numbers travel well to other years): 80.8% of all sub prime mortgages by dollar volume are AAA, 9.6% are AA, 5% are A, while the remaining 4.6% are Baa and Ba.
But according to Moody’s itself, the representative total pool losses by rating are: Aaa 26-30%; Aa 18-21%; A 13-15%; Baa 10-11%; and Ba 7-8%. Further, the CDS market – which are packaged/cobbled from these mortgages – can be infinite; financial engineers can (and have, given the demand for high yielding securities) create any number of securities off of the low quality subprime mortgage pools. Lastly, the problems are not just confined to sub prime obviously. Alt-A pools from 01- 06 are showing serious delinquencies and historic cumulative losses – and they are doing that when home prices are barely down, when rates have only recently gone sharply higher and when employment (if you actually believe the BLS) is at/near historic lows. In other words, these are GOOD times for the performance of mortgage pools and, voila, they aren’t performing well. What happens when a recession takes hold more firmly (as it inevitably will)?
On the accusation that we are merely ‘talking our book’: we are not short any of the ABX indices or, for that matter, do we travel in these circles from a trading standpoint at all. We are simply trying to understand the credit market dynamics of these instruments because we have believed for the past two years that the credit bust we see coming will originate from these murky waters. The troubles that the Bear Stearns hedge fund has had over the last two weeks speaks directly to this risk. The ‘’fat tail’’ potential in this area, given the amount of leverage utilized in this sector, is enormous. Who’s to say if the trade is crowded or not? Since crowded can’t be quantified, we prefer to stay away from conjecture and merely focus on the facts. We find that the very entities exposed to losses in credit derivatives are buying more assets to “prop” up prices is extremely disturbing.
The subprime mortgage pools are a symptom of a much much larger credit boom that has infected the entire credit spectrum, low quality to high. To assume that somehow credit problems in one of the largest ($6 trln in securitized mortgages) markets on the planet won’t impact the rest of the credit universe, or asset prices in general, is the stance that all these entities are taking, including your trader friend.
This is our main point: although Wall Street will try and try to talk the market into believing that stance, it isn’t.
-John Succo and Scott Reamer
this statement is telling:
Alt-A pools from 01- 06 are showing serious delinquencies and historic cumulative losses – and they are doing that when home prices are barely down, when rates have only recently gone sharply higher and when employment (if you actually believe the BLS) is at/near historic lows. In other words, these are GOOD times for the performance of mortgage pools and, voila, they aren’t performing well. What happens when a recession takes hold more firmly (as it inevitably will)?
I suggest that’s when home prices will be more than a little spongy…
The ramifications of this article are horrendous and scary. They have cut and diced things so many ways that it will take years to sort things out. Only thing left for people on this board is to find a safe haven for their savings while waiting for both housing and banking to unravel.
“veg-o-sledga-matic”… it slices, it dices, it slams any derivative… into a “profit”
Get yours today!
Where is that safe haven? Seriously, I’m struggling with this problem. Where would I invest my IRA (currently in a Principle Fund account)?
Any suggestions?
Thanks,
Lip
“The broker said the site allowed investors to purchase collateralized mortgage obligations with as little as 10% down and the other 90% borrowed, rather than the 50% down that is typically required on such margin accounts.”
This one comment just made me sit back and think about how much our economy depends on people being able to buy stuff without spending their own money at the time of purchase.
Is there anything you CAN’T finance these days for just about 100%? Where does it end?
Then again, maybe I should take that trip to Europe. Afterall, I “deserve it” right?
“I believe inflation will hit 1.5 million percent by the end of 2007, if not before,” he said. “I know that sounds stratospheric but, looking at the way things are going, I believe it is a modest forecast.”
U.S. Ambassador Christopher Dell about Zimbabwe
The problems in the subprime mortgage market aren’t yet well enough understood for regulators to propose a quick solution, said Cleveland Federal Reserve Bank President Sandra Pianalto.”
I think it’s time to be truly scared when a Fed Banker can’t understand the subprime mortgage market.
Mo Moneys “quick solution, 20% down, no 80/20’s, 30year or 15 year fixed conventional ONLY.
Mo money’s quick solution leads to 30% foreclosure rate, 50% housing price drop, COMPLETE collapse of the finaincial markets, and Greator Depression.
Oh Brother !
I guess I bought during the LAST Depression then
It isn’t that those conditions only exist during a depression. The problem is what that would do in today’s market.
Someone turned on a hydrant and a river started flowing down a street. Seeing the river, all the kids went and bought little boats and started floating the boats on the river.
Well, what happens if you suddenly turn off that hydrant? All the water dries up, the toy boats are left high and dry, and become worthless.
Housing prices doubled over a four year period because we completely disconnected ability to pay from price. $0 down, low intro rate, no doc, interest only, negative am….
However, not everyone took out these crazy loans… Some sold their $200K homes for $400K, then used the $200K as down on a $600K house.
So, now we have lots of people that can’t afford their homes that are desperate to sell or refi. The relatively minor changes so far of making people with poor credit history have a small down, has killed the market, making it VERY hard to sell. We’re starting to see Alt A also turned off, further removing potential buyers, makeing it harder for people in trouble to sell.
We’re seeing lots of foreclosures and short sales, and mounting inventories, and dropping sales, based on modest tightening standards.
So, let’s say we do what you want and further restrict access to credit, IN A BIG WAY. Then no one can sell as there are no buyers that can buy given your conditions.
Prices would HAVE to crash back to historic norm affordability levels. So, the people that are strugling to pay for a $200K house on their $40K income stop trying. BUT WORSE, the people that moved up, putting $200K down on a $600K house, suddenly realize that all the houses around them are selling for under $300K…. They too are upside down by a full year’s gross income, and they too walk away.
What is happenign at Bear Stearns today involving hundreds of million in firesales, and billions in bailouts, seems like a paper cut compared to the bleeding that will be happening as $1 trillion in CDOs become nearly worthless.
All construction stops. All lending stops. All shopping stops.
Go back to the Burnankie’s speaches of the last month… We have to stop making crazy loans, while still making jsut as many loans.
He is right. We need to make sure that people can still gets loans, or house prices crash, the countries financial markets stop, the economy stops… However, we also have to stop making crazy loans, since those casue mass losses and the houses just come back to the market a few months later….
The problem is, what he wants is impossible. Which is why they were looking to do an FHA reform that would have the U.S. Treasury issuing the loans and eating the losses instead of the private financial sector. That got shot down.
It is looking more and more impossible to do… keep lending just as much, without lending with such high risk… which is why the markets are having such trouble right now.
I think you just made me throw up a little. In my heart, I know this to be true, but seeing it in writing gave me an instant fright…
“So, let’s say we do what you want and further restrict access to credit, IN A BIG WAY. Then no one can sell as there are no buyers that can buy given your conditions.”
I’m here to help. I have cash and am ready to buy at such price levels. Kinda’ makes me fee patriotic, come to think of it. “Kids, grandpa helped rescue the economy and in the process got this kick-ass house!”
Second that, Chip. The market will be just fine — transactions would happen and the economy could return to a less distorted state.
Will there be pain? Yes, but it’s inevitable no matter what we do — trying to stem the “foreclosure crisis” would simply delay and magnify the pain in the end.
Better to get on with it and let the market do its thing.
Some interesting insight from Agora Financial:
A recent survey reveals three out of four Americans have not yet changed their spending habits in response to housing’s downturn. The Boston Consulting Group also released these results yesterday:
74% of Americans said they would be able to sell their home in less than 6 months for a price they think it’s worth
55% are “confident that their homes continued to increase in value compared with a year ago”
85% of those polled believe their home will rise in value over the next 5 years.
The Blackstone Group — one of the world’s largest private equity investment firms — goes public today. Its initial offering is a whopping $4.75 billion — the sixth largest IPO in history. Not to be outdone, rival group Kohlberg Kravis Roberts announced it too might be traded publicly in the near future.
“The buyout binge continues to amaze me,” comments Chris Mayer. “The number of private equity deals in the U.S. this year exceeds last year’s total threefold,” and far exceeds the market top in 2000. Mayer cites the work of Fred Hickey, editor of the Hi-Tech Strategist:
“Nearly $2.5 trillion of merger deals have been announced worldwide this year, about 50% more than the same period in 2000. Deal prices are running about 12.1 times the target’s cash flow, versus 9.7 times in that crazy 2000 period.”
And… virtually all of these deals are financed by debt. In the month of May alone, according to Bank of America, U.S. companies raised $143 billion in debt — a new record.
“When will it come to a head?” asks Mayer. “And who will be left holding the bag?” As Warren Buffett has pointed out, the problem with private equity deals is that there is no score card. “We won’t know whether these deals are good deals until years have passed,” Chris writes. “That’s good for the promoters, who continue to raise money to finance the next deal. It’s not so good for their investors.”
With regard to the Boston Consulting poll, it’s clear that there’s still a lot of denial out there.
“74% of Americans said they would be able to sell their home in less than 6 months for a price they think it’s worth”
The price I think “it’s worth”, is roughly the price that I think it could be sold for in ~6 months. What the hell are the other 26% thinking?
Yes, a bit of a tautology here.
the other 26% have been reading bens blog
“85% of those polled believe their home will rise in value over the next 5 years.”
******
Now that is utter nonsense.
In any case, with regard to the BCG poll (if I understand what they’re saying), I think it’s noteworthy that 25% of Americans have already changed their spending habits.
That is a very significant number this early in the bubble unwinding process.
About 1.5 yrs ago I made $100 with a RE agent friend/acquaintance of mine that the median price of houses in my town would be less in 5 years. I know he won’t “remember” and I won’t go after it but I’d say it’s in the bag. We also have a BRAC closure, in the next town 10 miles away, to be fully closed by 2011 releasing 2500 total housing units into the area. Last year I read in the paper it would equal 15yrs of inventory (i can’t imagine but that is what it said).
Am I correct that BS is loaning money from its other ’strong’ funds to its troubled funds in order to prop them up, without giving any transparency to where this loaned money is coming from or how these road kill funds will ever pay the money back?
Is this not unlike someone using a home equity line to make monthly mortgage payments?
How will BS show these ‘loans’ show up on BS’s balance sheet.
God, I hope they collapse under their own weight, just as many Fbs have done. This is getting real fun, as the collapse appears in sight. The financial companies are starting to get caught in their own web of deceit, greed, misrepresentation and outright lying.
That’s funny. This stuff is way over my head, but I had the same reaction: They’re acting just like the people who HELOCed their houses to pay the mortgage and their credit cards. Get out of debt by taking on more debt.
I do not have the financial education of most of the people here.
So I hope my questions don’t sound dumb.
If the hedge funds with MBS sell at fire sale prices, how will that reduce the home prices?
Or will the home prices fall because the money dried up and the sellers or the banks will take what they can get?
It won’t reduce house prices directly.
What happens is if those get ‘priced to market’, people will freak out about owning mortgage debt, making it immensely harder for the mortgage wholesalers to sell their loans, meaning they’ll have to tighten up their lending standards until people are willing to buy the loans.
If Wall Street refuses to buy their loans, they are forced to keep them, which they do not want to do. They run entirely on lines of credit, so they’d be passing money earned from the mortgage back onto the banks that loaned them the money. They’d far rather sell the loan and then make a NEW loan with the recently freed up credit line. They make money on the origination, not on the holding of the mortages.
So, if Wallstreet says “We won’t buy any more 0% down loans” 0% down loans go away. If Wallstreet says “We won’t buy subprime credit rating loans without 15% down” then 15% down becomes the minimum for a subprime loan.
When loans get harder to get, the buyer pool shrinks. When the buyer pool shrinks, houses have to compete for the buyers, either by waiting a long time for a buyer who loves the house enough to buy it no matter what the price (and can afford to), or by lowering prices.
That’s one mechanism.
The second (parallel) mechanism is purely psychological. Once people buying and selling houses truly believe that the whole subprime debacle will cause mass foreclosures and bank firesales, this belief itself will precipitate actual price declines.
Self-fulfilling expectations of price increases feed every bubble, and self-fulfilling expectations of price decreases end every bubble. The event that triggers the change in psychology can be any exogenous event - In 20/20 hindsight, people will always rationalize that “if only” mortgage rates hadn’t gone up, the bubble wouldn’t have popped, but in reality, if it hadn’t been mortgage rates, it would’ve been something else. Bubbles eventually collapse under their own weight.
“how will that reduce the home prices?”
New buyers won’t be able to get loans. People that need to sell to avoid foreclosure, can’t. When foreclosures happen, they pile up instead of actually being sold. Builders can’t sell and go bankrupt and their assets are added to the list of assets that can’t be sold.
All the big money management firms hold as many assets at overvalued prices for as long as possible, taking losses instead of gains. Eventually, the investors in these funds pull out. Funds are FORCED to liquidate some of these assets or go insolvant….
The fed either comes in with a rescue plan, or we head into greator depression. The former causes run away inflation, and the houses held by “the system” come down in price relative to rapidly rising inflation push incomes…If you have money in the bank, you’re toast, but if you have debts to your eyeballs, you’re bailed out.
or the former,the greator depression option. Houses are cheap as collapsing banks are forced to sell for whatever they can get, but few have jobs or cash with which to purchase them.
“In another fallout from Orange County’s subprime mortgage industry collapse, Brookstreet Securities Corp., an Irvine broker dealer, shut its doors and laid off 100 local employees because it could not meet margin calls on complex securities backed by faltering mortgages….”
Oh, the humanity! The mother of all mayhems! It’s begun!
“Financial genius is before the fall”
JKG
Regarding the Bloomberg article: Yikes! Cash is king! Also stock in large established companies with good dividends. I like stocks of companies that have been around several decades through several economic crises and with dividends. They know how to handle the storms. Their stock value may fall but dividends are generally about the same. It’s a way to also keep in touch with market reversals and not miss out on recoveries. A mixture of those and treasuries are a great way to be safe.
Feh. Guess you don’t remember that dark day in 2002 when TXU cut its dividend, can’t remember how much, but it was a lot. I sure do, I hate that company, but bought the stock when it got hammered.
It’s been a good day. I haven’t done a thing except one short sell and spent the rest of the day setting up spaying and neutering and getting food for some cats and kittens for a guy who’s unemployed and can’t afford it. Some people get off on paying Rod Stewart $1 to entertain at their birthday parties, I prefer helping the powerless. Ya’ll have a nice afternoon!
$1M to Rod Stewart. $1 would have been a hell of a deal!
Overpriced at $1.
Also, you’d have to pay ME to have Neil Diamond entertain.
Aww, c’mon, turn on your heartlight.
You don’t bring me flowers anymore
The FB’s are Forever in Bluejeans.
Don’t be a solitary man.
Guess you don’t remember that dark day in 2002 when TXU cut its dividend
That’s why I used the word “generally” in my statement. I look for a track record of increasing dividends in a company.
Bearish thoughts prowling the MSM. From Bloomberg, analogies with 1987:
“Yes, the ‘87 crash proved to be a bargain-hunter’s bonanza. That by no means assures us that the next calamity of this sort will turn out the same way. More definitely, this episode shows us to what amazing extremes markets can go independently of whatever happens in the world around them. Long-term, without question, the stock market is linked to the progress of the world economy; short-term, all bets are off. “
“One action the Fed is reviewing is whether to write a rule about lending only to borrowers with proven ability to repay their loans. Edward Sivak, director of policy and evaluation for Jackson, Miss.-based Enterprise Corporation of the Delta, urged such a rule.”
From Uncle Fed’s Banking 101 course, Rule 1: “Only lend money to people who will pay you back”.
That is classic, just classic. And they pay these bankers how much?
Hardly bankers…
They are Pig Men - simply the gross caricatures of bankers gorging themselves at the trough of global liquidity.
but people that can afford to repay don’t pay huge fees and interest rate spreads. if you want to create wealth, you have to make high risk loans, then transfer the risk to a bag holder before it collapses.
“One action the Fed is reviewing is whether to write a rule about lending only to borrowers with proven ability to repay their loans.”
Dah, novel thinking here!! But, but, but if you do that what will happen to the CC market and the economy? Nah, let’s keep lending where it is so we keep ‘em working to repay debt. Our motto: remember the ole mining companies where they owed their souls to the company store.
Blackstone down to 34.87 from 36.45 open..
This is the deal that EVERYONE wanted in on???
A couple of thoughts: Regarding Bear Stearns bailing out their hedge fund… in the late stages of a Ponzi scheme, when new “investors” are running low, the original ponzi founders will often re-buy into their own scemes, enabling the illusion of solidity to last a while longer. This enables the ponzi to draw in the last few possible fools, just before the thing totally explodes and is exposed for the empty shell it is.
I once had a friend who bought into a ponzi scheme (it was called an investment corporation; basically rasing funds from new investors to pay old investors a 20% guaranteed annual return. The old investors are encouraged strongly to keep re-investing their 20% return). It sounded very suspicious to me, but he was reassured by the fact that the president of the organization had just re-invested some of his own money. Sound familiar?
The real estate/MBS/CDO ponzi is in the late stages. The solidity of 100% valuations is just starting to waver. We’ve seen the first desperation move by Bear Stearns. More may follow because the alternative is very scary to very many people. I suspect the government/Fed may step in and overtly or covertly buy up these loans to keep them marked at 100% value.
In concert with that, there are many plans for Fannie May and Freddie Mac to buy up bad loans and re-negotiate them, possibly including 0% interest and deferred payments– or more simply put, a massive government bailout at the expense of taxpayers.
I would like the Fed to step in and buy up all the bad CDO’s. Isn’t the Fed a privately owned company? I think they should be the bag holders.
add: the Fed and it’s share holders
Agree. It doesnt make sense the government should pick-up the slack when they don’t control the rates.
But then again, the government always wants to come to the rescue, even when it’s not their responsibility to do so.
A fitting quote from Bear Stearns’ CFO:
“We didn’t anticipate market dislocation of this degree,”
When levering 90%, you mustn’t have anticipated any MINOR dislocations.
It was mentioned earlier that if housing prices tumble, all lending ceases, and the system basically locks up, leading to a Greater Depression. The Fed and the rest say they have to keep making loans, but “not risky ones.” Not possible - housing prices are simply not affordable based upon incomes. There simply is no way to make “non-risky” loans since the only thing that drove the prices up was the presense of risky loans - well, that and stupidity and greed, but they are always parts of the system.
The Fed could try to inflate its way out… or perhaps not. Then, China and the rest of the nations stop buying our debt - they are already moving away from it - and the dollar ceases to be the world’s reserve currancy.
From where I sit, there is no straightforward way out. Only a hope that somehow, the whole system doesn’t come apart completely…
“One action the Fed is reviewing is whether to write a rule about lending only to borrowers with proven ability to repay their loans. Edward Sivak, director of policy and evaluation for Jackson, Miss.-based Enterprise Corporation of the Delta, urged such a rule.”
“‘We’re living in the unintended consequence right now,’ he said.”
But not unforseen,
So as the melt down continues the financial experts spin new lies, but the truth starts to come into focus, soon it will be obvious to everyone that wall street is running on the enron business model. There will be investigations, supeonas, blah- blah- blah………
They’ve killed the golden goose, the greed is unconstrained. Pour bastards, who has the most to loose, the already beaten down average American worker or them?
Sixteen years of frat boy Presidents and a “whats in it for me” Legislative branch have sealed the fate of the Rebublic.
My solution to this whole problem; The Universal Bankruptcy Act of 2008. First we will have deflation, then the Fed will steps in to hyper-inflate, Zimbabwe style. This Will not due. The Congress should then step in to seize control of the money supply. Declare all debts public and private null and void, except for corporate debt(their on their own),with the Universal Bankruptcy Act, if foreign countries object, TS, what are they going to do about it. Print enough money up to give each citizen $5,000, max $15,000 per family, to keep the economy going after initial signing by the President. Property may be kept if person can prove 100% deed of ownership, then we start all over. Money backed by gold and silver, with private owner ship thereof, with value set by the market. Ban all CDO’s, Derivatives, and Hedge Funds, forever.