Very informative. I am not sure that all the holders of these types of securities would be happy to read this, but my feeling is that one is always better off knowing. I think the releases on the downgrades on bonds become a lot clearer for most people after reading this.
I am not sure if it is clear that the snowball nature of quick defaults on a mortgage pool can actually be magnified by deep tranche structures. If the initial assumptions are off by too much, the same structuring used to grade up parts of the security can become an assurance of significant principal loss for some of the lower tranches.
It would be nice if you would put a link on top of the post to parts I & II. Maybe, by a kind fate, some pension fund investor might happen across this. You never know whose retirement you might be saving!
"get there eventually"? It's sat. a.m. & you've already worn ME out. Have a great weekend, I'm going house looky-looing. It's a hoot to listen to SoCal realtors explain that anti-housing media bias has created enormous buying opportunity.
So: An investor can choose an AAA-rated MBS, such as an agency pass-through, backed by high-quality mortgages. Or the investor can choose an AAA-rated tranche of a REMIC, paying higher interest, backed by lower-quality mortgages. Supposedly both carry similar levels of risk, as the rating implies. Apparently, the difficulty of restructuring the REMIC if things went awry never went into the calculation of a credit rating. Also notable is that in the example given, the top three tranches received AAA rating even though their initial CEs differed wildly, from 43.9% to 6.5%.
Oh, and I think your readers might find the recent Fremont downgrades very illuminating. Shoot, man, what's to worry about an 8 month seasoned pool with a performance like this:
"Series 2006-B pool 2 was structured to have growing OC; however, the OC did not reach the initial target of $23.9 million. Monthly losses have exceeded excess spread for the last three months and completely eroded the OC as of the April 2007 distribution date. Based on the performance to date, Fitch expects class B-1 to continue incurring principal write-downs."
and:
"Class M-11, rated 'BB+', placed on Rating Watch Negative. Series 2006-B Pool 2 Class SL-A affirmed at 'AAA'; Class SL-M1 affirmed at 'AA+'; Class SL-M2 affirmed at 'AA+'; Class SL-M3, rated 'AA', placed on Rating Watch Negative; Class SL-M4, rated 'AA-', placed on Rating Watch Negative; Class SL-M5 downgraded to 'BBB-' from 'A+' and placed on 'Rating Watch Negative'; Class SL-M6 downgraded to 'BB-' from 'A' and placed on Rating Watch Negative; Class SL-M7 downgraded to 'B' from 'A-' and placed on Rating Watch Negative; Class SL-M8 downgraded to 'C' from 'BBB+' and assigned a distressed recovery (DR) rating of 'DR6'; Class SL-M9 downgraded to 'C' from 'BBB+' and assigned DR rating of 'DR6'; Class SL-B1 downgraded to 'C' from 'BBB' and assigned DR rating of 'DR6'."
Pool 2 is second lien; Fremont's servicer rating is now RPS4. Gives you a warm cozy feeling, doesn't it?
I'm a big fan of yours. I'm following Annaly Capital Management (NLY), a REIT that mostly invests in MBS. As I'm new to MBS, your MBS for UberNerds helped me a lot. Thanks a lot for that!
Their portfolio is made up 75% by GSE MBS, which are divided like this:
20% ARM pass-through certificates
72% fixed rate pass-through cert or CMOs
8% ARM CMOs
It's is according to them a pure yield curve play. Many of their holdings lost value, which didn't impact their earnings, as they claim it does not affect them as they intended to hold those securities for the long run.
Although, they are very leveraged 10.4:1 and depend on the value of their MBS to be able to keep on borrowing in order to buy new MBS. Am I correct in assuming that it will hurt them? If the MBS lose value, doesnt it imply that the rating was not accurate?
About the "yield curve play" what puzzles me is that any relatively big movement in the interest rate will hurt them. If rates go up, more people in the ARMs will face default (that looks like a prepayment to them as their are GSE). If rates go down, borrowers will refinance (which will look like a prepayment too).
Am I looking this right? Any thoughts are really appreciated as I feel kind of lost with this one.
Abe, the part that gets to me is that nobody wanted the plain vanilla AAA MBS because its cash-flow characteristics were too unreliable. The GSEs only protect you from principal loss; they don't protect you from prepayment risk. So all this fancy tranching is also supposed to help you hedge your prepayment risk. Ooops! Don't pay any attention to what that did to your credit risk . . .
I'm also entertained (in the usual sick way) over this "super senior" business. If anyone can find an actual credible definition of "super senior," pass it on, I'd love to know. As far as I can tell, it's just a way of pretending that that top tranche is "really" AAAA, not AAA. (Of course there's no such thing as an AAAA rating.) But I do wonder if there are people who think that you can actually do better than getting repaid. I just hope they aren't in the mortgage business.
Am I correct in assuming that it will hurt them? If the MBS lose value, doesnt it imply that the rating was not accurate?
It's hard to say without knowing what their cost of funds is.
And remember that GSE MBS never get downgraded. They are always implied AAA. They might lose market price, because they yield less than a new bond, or they might get so old (so prepaid) that they don't yield much, but they don't get downgraded. You can, if you're an institution, hold them to maturity without worrying that you'll have to unload because the rating went down.
The ugliness with some of these senior REMIC tranches is that someone, like an institutional investor, who has to have that AAA on its investments might have to unload, at a bad time, just because the rating went down.
I honestly don't know enough about Annaly to have a worthwhile point of view about its hedge on all those fixed rates.
the AAAA rating was developed, for your knowledge, approximately 12 months ago by private equity, they instituted the AAAA rating as a way to label the bonds that they would need to take out and pay handsome premiums to do so (regardless of prior rating) before they turned them into deep junk in order to remove the existing covenants.
risk capital, maybe it's an "AAAAArms Race." You know how much these masters of the universe like to get into pissing contests. "Oh, so you issued some weaselly AAAA Super Senior? Well, Jack, I'm issuing an AAAAA Super Duper Senior. Worship me."
Can someone comment on the new FHA expansions and if this is enough to re-spike the punchbowl?
Here are comments from the head of the FHA:
"I think we have some better solutions to the problem, both short-term and long-term. We can re-ignite the housing boom if we are prepared to make some important changes."
Perplexed, I promise I will do an intelligible post soon on the FHA "reforms." To be honest with you, finishing the current installment of MBSopedia used up most of the spare brain cells I had this morning, and my next trick is to find the most irritating YouTube out there for Saturday Rock Blogging. I know that says something about my priorities that I should be ashamed of, but I'm just a mortgage banker. We're punks. Get used to it.
So everyone will have to settle for "I think 99% of FHA reform proposed is DSM-III level insanity," for now.
1 Bears don't have to compete with the larger number of "bulls" who tend to be right, by varying degrees, some "95% of the time." The market is up, on average, 8-10% a year leaving the permabears shoveling shit in Petaluma 95% of the time.
2 Forget the facts, fear sells even bigger.
3 Bears don't keep score based on performance results (that would put them out of business in a heartbeat), he keeps score by the amount of fees he can generate.
4, There are always enough fools and investment pigmys out there to make it worth his while to peddle his brand of snake oil. Likeminded financial morons travel well together.
5 Bears arent investment guys, theyre marketing guys (snakeoil peddler) with a flim/flam niche.
6 Bears are focused on yesterday because its easier than being focused on the future. If you notice, they spend an inordinate amount of time analyzing, agonizing over and discrediting both the reported data and/or the sources of that data. Real investment guys look forward and don't drive their portfolios looking in the rear view mirror.
7 Most good money managers tend to be optimistic (because of #1), PermaBears are always pessimistic.
Its always very easy to spot those financial pigmys and investment dwarfs who have not participated in the last 5,200 points of the market rally.
Tanta, it looks like someone shoved a live snake up your ass over on the other thread. Don't get to uppity, girl, or your covered parking priveledges will be revoked. Capiche?
GOOD MORNING WART DOCTORS...
Your role is to constantly re-energize the "wall of worry" needed for bull markets to climb. Loading up with puts at market bottoms also helps; you have yet to let us down.
In contrast, my role is very different. My job is to make money--bushels full of money.
Keep up the good work WART DOCTORS...so far, so good! I knew that I could count on you--again!
Let's face it, some folks were put on this planet to produce wealthy families...others are here to shovel shit in Petaluma.
So, "Bears," did you steal that from this commenter at Kudlow's blog? Or are you the same commenter, but not willing to use the same handle on this blog? And where did you get the idea that we care about your comments to a Kudlow post?
Perplexed said: "BTW, sorry if this is off-topic, I am just really worried about this..."
Tanta, congratulations on your latest successful conversion.
Now, how do we know when all this will come home to roost? How will we know if it comes to roost?
You've shouted "FIRE!" in a crowded theatre, while ignoring the fact that there's a sprinkler system installed and fire extinguishers available. Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?
"...or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?"
WAKE UP, BUTTERCUP!
These are angry, lonely, passed-over, under-achieving, life long middle manager's here who are capable of cubicle duty and can see within those four padded walls - but no further than that.
Anony blogging fear mongering is their one and chance to role-play the part real life has cheated them out of.
These financial simpletons spend their entire day discrediting all financial reports that disagree with their forever-wrong case or discrediting the source of the reports. (And when theyre not doing that, theyre monitoring the blog, deleting all those "trolls and assholes" who visit it). But when it comes to their always-wrong projections, they can't do that so they simply bring up all sorts of fabricated qualifiers--"I really didn't say that, this is what I really said," bullsh*t.
Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?
Sebastian, I'll pass over the "difficult to understand" part. If you can't follow this, you shouldn't be investing in mortgage-backed bonds. That's all. That is not shouting "Fire." That is suggesting that your risk tolerance has been exceeded if you don't know what your risk is. Investment 101.
But where do you get "impossible to verify"? There's a giant internet out there, Seb, and it's chock-full of information from hundreds of sources. Fact-check me, kid! Go to it! Go to U.S. Securities and Exchange Commission (Home Page) and download some prospectuses! Read every methodology paper on the rating agencies' websites! Hit the Bond Market Association, the American Securitization Forum, and the Hudson Institute! Pick up the phone and call industry experts in the MBS trade and ask them to review the document! Go nuts! You want to evaluate my credibility? It's so easy to do! Just do some work.
But until you have done that, please do not confuse "I cannot verify your facts" with "Your facts cannot be verified."
We have had occasion before now to remind you of the difference between something you don't understand and something that is wrong.
PERMABEARS AND FINANCIAL PIGMYS...THIS IS WHAT WERE FIGHTING AGAINST:
...despite all of the permabear poop, the OECD core CPI inflation rate has remained remarkably stable between 1%-2% since 2003. Thats because all those relatively scarce (high priced) commodities have been converted (by cheap labor) into a glut of (low priced) consumer goods. Global competition has forced manufacturers to increase their productivity to offset rising materials costs since they cant raise their prices.
Permabears are trapped in a 1950s intellectual hammock.
Globalization is eating your lunch faster & faster every day--and the whole planet is getting richer...just hold your breath and make it go away.
It started before Subprimogasm and you think that your pathetic and failed bubble theory, anger, hatred, foaming at the mouth, bitterness, envy, victimology, unaccountability, non-responsibility, unpatriotic anti-Americanism, whinniness, pissiness, moaning and self-loathing and moonbattery will make it go away?
Isn't it fascinating, Vader? I mean, I'm loving all this "middle manager" stuff. Where's that coming from? The belief that only CEOs have insights? Or that people who have a discount brokerage account and watch Kudlow have a point of view worth listening to, but people who, oh, manage brokerages don't?
These guys claim to be such loyal patriotic Americans, but it seems to bother them to no end that not everyone is forced to agree with them, and that actual middle managers are allowed to use the internet, which I guess these guys think should be restricted only to the superior class. I guess they think that productivity and corporate earnings will rise only if workers and middle managers are muzzled and silenced, and that recycling someone else's work is "production." And yet they wonder why the rest of us don't want to take their bets . . .
Globalization is eating your lunch faster & faster every day--and the whole planet is getting richer...just hold your breath and make it go away.
It started before Subprimogasm and you think that your pathetic and failed bubble theory, anger, hatred, foaming at the mouth, bitterness, envy, victimology, unaccountability, non-responsibility, unpatriotic anti-Americanism, whinniness, pissiness, moaning and self-loathing and moonbattery will make it go away?
All-time record high earnings and earnings gains that beat expectations, low interest rates, low inflation, world economic growth pushing a bodacious 5% annual rate, 4.5% unemployment...combine that with stocks that are nearly 30% undervalued v. bonds, record put buying of a few weeks ago, record global liquidity and a multi-billion $dollar "deal of the day" and you have the makings for GOLDILOCKS BABY!
Stocks are undervalued compared to bonds by some 25-30%, its been over 25 years since we last saw such a huge valuation gap, a gap that ALWAYS gets closed. And since we used so little financial energy moving that "CotD" dot up to the "best-fit" normal line to date, we still got a lot of ooomph left in the tank to get there.
OMAHA, Neb. -- Billionaire Warren Buffett repeated his warning that the growth of derivatives and excessive borrowing by traders, investors and corporations will eventually lead to significant dislocation in the financial markets.
In fielding a question about derivatives, which he once referred to as "financial weapons of mass destruction," Mr. Buffett told some 27,000 shareholders at the annual meeting Saturday of his Berkshire Hathaway Inc. holding company in Omaha that he expects derivatives and borrowing, or leverage, would inevitably end in huge losses for many financial participants.
There was a great global economic boom during the 1950s and 1960s, but it was limited to the postwar reconstruction of Japan and Europe, and the transformation from a war-time to a peace-time economy in the US. Many economists predicted a depression would follow the end of World War II. Instead, there was a great postwar boom, but the resulting rise in standards of living was enjoyed by maybe 500 million people. Today, at least 3 billion people are prospering, especially in the emerging nations. Prosperity, however, is not a zero-sum game. So prosperity in Asia, the Middle East, Eastern Europe, Russia, and Latin America is providing lots of stimulus to the industrialized economies. Ah yes, 3 billion new customers compared to a total EU population of only 450 million.
The way it looks now, the current world wide economic boom could easily last for many more years-maybe even decades. With expensive raw materials being converted into cheap consumer goods by an abundance of inexpensive labor (that 3 billion mentioned above), inflation looks more like TAPIOCA than any real serious threat. Interest rates will remain historically low for the foreseeable future. Capital will rapidly migrate to where it is treated best.
The American Enterprise Institute (yeah, I know, but their banking analysts are pretty good) held a Subprime Seminar last March 28th. At the beginning of the Q&A Chris Whelan responded to a question by Bert Ely and made an interesting remark on enhancement. I'll be posting with a transcript of that exchange in a few days, but for now here's the bit that relates to today's topic.
... But I think ultimately you've got to remember that the deals that are rated investment grade oftentimes are rated that way because a rating agency gave them that blessing based on the collatoral and the enhancement, and there's probably a hedge fund or somebody else who's provided a credit derivative enhancement to that structure, and they may have to be called upon to perform. And if we see default rates go back and achieve the same levels we saw in the early 1990s or higher, which is what some of the data you've seen today suggests is possible, then we're definitely going to stress those assumptions. And I think you're going to see not only rating agencies, but a lot of hedge funds who have been writing default insurance below economic rates really get into a lot of trouble.
You know, go back to what I was saying before. People were being paid a point or two points a year in a premium on a credit derivative contract to insure a portfolio that's going to throw off ten or fifteen percent a year defaults. You know, what's wrong with this picture? And that to me is the underlying issue, really, with Bert's question is, you know, these securitizations are seen as good sales. But maybe they won't be, but we'll leave that up to the trial lawyers.
Sebastian, you wrote: "You've shouted "FIRE!" in a crowded theatre, while ignoring the fact that there's a sprinkler system installed and fire extinguishers available. Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?"
The idea that Tanta's information is just wrong or impossible to verify is refuted by the wave of downgrades on MBS bonds lately, federal regulatory agency warnings to banks, SEC filings, etc. Her information is very easy to verify.
I really do not understand where you are coming from on this one. You seem to define "irresponsible" as "telling the truth". The entire financial regulatory structure places great value on disclosure of information to any prospective investor. The idea that explaining investments in plain English is somehow "irresponsible" is risible; it is in fact a statutory requirement.
The only thing Tanta has done with this post is provide the average person with the ability to read and understand a downgrade, affirm or negative watch notification from a firm like Fitch. If you are objecting to that, you have a heck of a problem.
As for sprinkler systems, etc, those who have already incurred principal losses would disagree that these systems were in working order. It is extremely unpleasant to find your As turning to Bs or Cs, granted. If you want to blame someone, blame the originator, securitizer or the ratings firm, not the person who is explaining what all this stuff means.
"The market can be an expensive place to find out who you are."
The market is the best barometer of the planet's collective wisdom at any given time. And like most barometers, it is also subject to change. And it is forward looking. When you think that you know more than the market or have a better forward looking barometer, then you are headed for a big fall. You are right and the market is wrong. Exactly why Permabears bring no added-value to the table--the sky is always falling and the glass is always half empty. They never get close to seeing the "Big Picture. They just discovered the abundance of global liquidity and global savings glut after a 6000 point advance in the DJIA.
BEARY BAGHOLDZ is another similar animal--he too can't deal with the future and how that market barometer can change. They drive their investment vehicles looking in the rear-view mirror and are always in crack-up mode.
I am first of all baffled as to how Tanta's post can be considered either "bearish" or "irresponsible." I see an industry insider describing how the industry works. She is, as always, quite careful to limit her conclusions to the data.
Second, I'm trying to understand the conflicting interests of the tranches given what you've said, Tanta. Let's say that a lot of the loans in a particular pool start going belly-up. Is the problem that the Super Senior trancheholders are OK with this so far? That the problems have to get really bad before they start getting affected, so they don't want to be deprived of the loss of income that would result from a massive number of modifications?
On the other hand, would the Toxic F- trancheholders badly want to see the loans modified because as things stand, they are going to get nothing, and anything is better than that?
Am I off-base? Apologies in advance for any terminology misuse. . .
Well since the economy is doing so great... let's continue the rise of the interest rates! Certainly the strong economy can handle it. You're not begging for rate decreases are you?
Tanta,
My boss just had to write a white paper for some company's credit deriviatives holdings. He had to make assessments on the risk. This guy is super smart and I think his head was ready to explode.
I don't see how the price can be priced effectively in this current marketplace of unknowns. With time, the market will figure it out. Until then?
For me, reading this blog's posts and the comments thereon is like attending a seminar in which I can hear and participate in discussions among civil, intelligent and serious people. Having some civil and serious dissenters such as Sebastian, banker, and Steve in the group is useful, as they stimulate debate.
When Sock Puppet heaves into view, however, I feel as though a perverted, syphilitic lunatic screaming filth at the top of his lungs has barged into the seminar room.
Let's say that a lot of the loans in a particular pool start going belly-up. Is the problem that the Super Senior trancheholders are OK with this so far? That the problems have to get really bad before they start getting affected, so they don't want to be deprived of the loss of income that would result from a massive number of modifications?
You're doing fine with the terminology, Amadis. I haven't seen a lot of F tranches, although there are really things called "Z bonds," so never think parody can get ahead of reality.
The thing is, basically, that unless the pool is just ungodly unbelievable worthless junk, the senior note holders are never going to lose any principal. There have been some very bad securitizations out there where senior notes have lost money, but I still think most of them will not take a write-down.
The trouble for the seniors is two-fold:
Prepayments speed up, and they get their money back too fast. If you're only making 10 bps over LIBOR to start with, and you get it all back in six months, you have to reinvest. You might be OK with that if rates rise, and you can buy a new senior tranche that yields more. But you don't tend to get rapid prepayments when rates are rising, because that means the loans aren't in the money for a refi. So you might be in favor of modifying in this case--what do you care about lowering the borrower's interest rate? You're only making 10 bps over LIBOR. The real risk-holders at the bottom of the pile, who get the higher yields, might object at this point. For them, the sooner the senior is paid off, the sooner they get money that is going to OC.
As the OC and the lower tranches take the write-downs, the seniors get downgraded. For a retail investor, that wouldn't matter. For a depository, or a hedgie who has this tranche in some CDO portfolio that needs that rating to deal with its own pool quality problems, then the downgrade could force these investors to have to sell. It's like with the refi-prepayment thing: probably going to be at the wrong time. So the senior might want to see mods rather than FCs, because it means less of a hit to the CE. The middle-level subs might want to see FC rather than mods, so that the seniors pay off faster and the OC is released. They're going to take a downgrade anyway. The bottom subs might have to worry about a downgrade into junk territory.
Think about it like foreclosures: you are most likely to have to foreclose at the time when property values are dropping. You don't tend to have to foreclose when houses are appreciating every day and so your REO might be worth something.
This is the market mechanism that the securitization structure didn't "solve." I do not claim that every bond salesman claimed to have "solved" this problem, but a whole bunch of them have acted as if they did.
Amadis,
Tanta's article uses easily verifiable facts relating to market mechanisms and draws no conclusions and therefore, cannot be irresponsible.
That poster is an older version of a babbling know-it-all teenager. He also posts bragging about his latest master day trade, etc.
We should be grateful for market participants who base their decisions on catchy patriotic american slogans. They are a rich source of exploitable market inefficiencies. Sadly, this sort have only nugatory means to piss away. They seek only to please their betters and on Monday (they have no private income) they will be kissing asses for preferment with the characteristic unctuous deference of their class.
The Industrial Age peaked out around 1965 (40 years ago), and manufacturing has steadily declined as a percent of GDP every year--even though in absolute terms manufacturing hits a new all time record high each and every quarter. The 20th Century Industrial Age replaced Agriculture over 100 years ago, when 50% of all jobs were on the farm. Today its 3-4% and going to 1%--and we now feed the world!
The Information Age/Service Economy (Technology Age) did likewise to manufacturing 40 years. Low paying, blue collar (union) jobs at the plant, factory, foundry and mill requiring little education and skill (labor) have been replaced by higher paying professional jobs (involving intellectual property) requiring more skill and education in the areas of medicine, engineering, law, education, financial services, etc., etc.
Joe 6 Pac and union laborer have been replaced by Wong and Vishnu abroad, just like Joe 6 Pac replaced the Buggy Whip guys in 1905. Education and brain power has replaced long hours and a strong back as the primary requisite for success in today's modern and increasingly globalized economy.
And American wealth, prosperity are hitting new highs every year and we are all enjoying a higher standard of living as we live longer and healthier.
Bottom Line: Put that buggy whip, plow, shovel and hammer down and get your ass into a classroom where you can secure a relevant position in today's modern economy. Either that, or you'll be shoveling shit in Petaluma for the rest of your life.
BUT THEN AGAIN...
SOME FOLKS WERE SIMPLY BORN TO SHOVEL SHIT IN PETALUMA...AND MAYBE EVEN ENJOY IT.
Where is my job? Where did all the jobs go? When I entered college code monkys were banking signing bonuses and 100k per year salaries plus stock options. Now little brownpeople in Bangalore are doing my job for $1.65 an hour. You owe me. I'm entitled.
Education. Skills. How quaint. First one must compete for the chance to rub elbows with one's betters at the finer schools. Failing that - my condolences - a bit of occupational training can mitigate the hardships of one's caste.
I am a simple minded guy. Almost every day I see in the grapevine those morgages request that can not be paid back. Not all, just a few but they are there.
Why are lenders giving away this money that could not be paid back ? How is this whole MBS thing allows them to recover from such mistakes ?
We have a right to data mine and cherry pick negative "facts" and draw a straight line conclusion to our predetermined doom scenarios without seeing the actual positive reality. We like to and it's our right.
Where's that subpoena guy or Taxta to legal action here?
My rights are being trampled on, I feel violated, dirty even.
"When I entered college code monkys were banking signing bonuses and 100k per year salaries plus stock options."
Aww c'mon Tremulous Timmy, AKA Bear Scat and all the other handles, now we know you're lying. You haven't entered college yet; maybe a sophomore in high school at most, probably w/o many friends, a bit closer?
You can't do better than a cheap dialup connection but since that means your ISP gives you a different IP address from its available pool each time you log on at least you're harder to block when you become a pest; a bit closer still?
How about you got busted for plagiarism at school and are spending a lot of time in your room, fooling around on the internet cutting and pasting stuff while trying to get a rise out of people when the parents aren't home; even closer yet, hmmmm?
You've never invested in anything other than your right hand have you? C'mon kid, give it a rest; you're not fooling anyone here.
Mish highlighted Caroline Baum's article, but, this quote is classic,
"Imagine how it would look if Congress were to ask him to explain why the Fed let the economy slip into recession with inflation so low. Would Bernanke be able to keep a straight face when he told them that GDP ex-housing was solid?
Heck, GDP excluding consumer spending, business investment, housing and exports was robust in the Great Depression, too."
Reading your description of pass-throughs, REMICs, traunches, and evermore complexity piled on complexity, I am struck by the question: "Does everyone involved have the accounting systems in place and the sophisticated staff to accurately track this stuff?"
I suspect that accounting clerks who are inputting the data don't understand what all the variables and fields they are populating mean. Their managers might be masters of debit-and-credit algebra, but if they could do calculus and advanced statistics, they would be actuaries. They traders might understand the math, but their willingness to translate it into accounting probably ends when they are comfortable that the bonus measurement module when give them the answer (think Joe Jet and rollovers).
In short, everyone is fooling themselves that they have an accurate measure of what is going on. It is the "unknown unknowns" that will get them, plus cluelessness about these unknown, unknowns so everyone keeps playing double-down.
""The introduction of derivatives has totally made any regulation of margin requirements a joke," said Mr. Buffett, referring to the U.S. government's rules limiting the amount of borrowed money an investor can apply to each trade. "I believe we may not know where exactly the danger begins and at what point it becomes a super danger. We don't know when it will end precisely, but ... at some point some very unpleasant things will happen in markets."
Subprime defaults made worse by securitization: Buffett
By Barbara Kollmeyer
Last Update: 1:34 PM ET May 5, 2007
OMAHA, Neb. (MarketWatch) -- Rising defaults in the subprime mortgage business have been exacerbated by securization of these loans, Berkshire Hathaway Chairman Warren Buffett said on Saturday during the company's annual meeting. Subprime mortgages are offered to poorer people with blemished credit records. The loans are often packaged up and sold on again to investors as mortgage-backed securities. "Once you package those things and sell them through major investment banks, discipline leaves the system," Buffett said. Subprime borrowers have been missing their first and second monthly payments recently, he noted. "That shouldn't happen. Securitization has made the problem worse," he added. A slowing housing market has triggered turmoil in the subprime mortgage business this year. Legislators have been discussing possible new regulations to deal with the crisis, including making investors in mortgage-backed securities more responsible for future delinquencies. Subprime defaults made worse by securitization: Buffett - MarketWatch
"...including making investors in mortgage-backed securities more responsible for future delinquencies."
This seems poorly stated by the reporter -- how could an investor be responsible for a default rate -- but sure, why not, it should be the responsibility of any investor to read the prospectus w/ acceptance of risk an inherent part of that process.
However, even though I suspect legislators would love to leave investment banks -- major political contributors that they are -- entirely free of liability for the products they produce I suspect the net result could be an increase in the cost of mortgages to the end-borrower unless developers of MBS synthetic products are also held responsible for the structure of the loan pool therein.
RW, I think the reporter had been told something about HOEPA loans. Purchasers or assignees of HOEPA loans inherit all claims that could be made against the originator, and are bound by the same restrictions as an originator. This liability pass-through was necessary to prevent evasion of the purpose of the law. Without it, a loan could be written, sold, and then the borrower could be victimized with no legal liability. Financers could simply sell these loans back and forth and bypass the rules.
It's questionable whether a subprime originator, purchaser or assignee writing a low fee loan at 7.5% should be bound by the same rules.
On the other hand, neg-am consumer purchase mortgages, should, IMO, be subject to similar rules. The way that many of the current neg-am (Option ARM) loans are structured, the consumer winds up paying interest on interest. This may well result in the same sort of equity stripping and constant under-the-gun refis that HOEPA was originally written to block. This is equity stripping in its purest form.
If you take a look at some of the newer products, some of them turn into HOEPA-like loans later on. HOEPA does not cover loans which have lower stated interest rates at consummation, but when you start charging interest on interest it mounts up quickly. When offered to unsophisticated borrowers such as Amadis of Gaul's friends, the end result can be very similar to the type of situation for the borrower HOEPA was written to prevent.
In addition, many states have legal provisions limiting recourse against consumers for purchase-money mortgages. Writing a loan that will force a refi before reset or shortly after essentially strips the borrower of this protection.
There is more to HOEPA than this, but Title 12 226.34 will give you an idea of how the liability pass-through works. Needless to say, the end market for HOEPA loans is limited.
Thanks Tanta for an eye-opening explanation of the derivatives market. Should be interesting to see just how the Law of Unintended Consequences kicks in through the coming years.
The person have already missed a payment. can not doc his income. Has low FICO score but neds cash out on a $1.5M home. (when was the appraisal done ? is the house still worth $1.5M - maybe it is only $1.3M by now ???)
The person wants a neg-arm meaning he ca not really pay the cost of this home but for a minimum pay of the teaser rate he can stay for two more years at this home.
Anyone really think this will not end up in default ????
I don't know about your skepticism on super senior tranches Tanta. It seems to me that come '08-'09 the difference between 43.9% CE and 6.5% CE could be a useful one.
It's not so much yelling fire as giving a short description of the fire code, including a discussion of the number of fire doors, time to exit, and presence of sprinklers.
I don't feel so much that this is a seminar that I've been inveted to as that this is the first time that I've been able to eat at the "grownup table" at Thanksgiving. I'm trying hard to follow the conversation even though I'm out of my depth. I'm learning alot and can occasionally say something that adds to the conversation, so I'm quite proud of myself, and feeling like I'm one of the "big kids" now. The fact that they've also let my spoiled, screaming four-year old cousin sit with us rather detracts from my joy. Getting away from him and his food flinging was supposed to be one of the joys of this thanksgiving.
I don't know about your skepticism on super senior tranches Tanta. It seems to me that come '08-'09 the difference between 43.9% CE and 6.5% CE could be a useful one.
Certainly, if these puppies are still around in 08-09, that super-dooper CE will be handy.
But who the hell wants to earn 10 bps (or whatever it is) over LIBOR for that long?
Given what it costs just to do the accounting on this stuff, and pay the broker for it, I'd be inclined to buy treasuries. In fact, I admit, I own a lot of short-term munis. If I'm going to get "risk free" yield, I don't want to pay loads for it, and I don't want to have to hire KPMG to do my tax returns. (Like that would help, but still, I would be expense.)
I'm just a mortgage punk with a bad habit of watching out for nickels and dimes: you get that kind of training in the prime conforming market, because it's all nickels and dimes until its jillions, but the jillions don't tend to be gains.
So someone else will have to explain where the "super senior" becomes the value play. It looks to me like no risk and no return. You know, like eating candied sweet potatoes with marshmallow topping. As long as you bring the casserole to the boiling point for at least 20 minutes, the germs won't kill you. But then you have to eat it. In my view that takes a bit of the fun out of being at the grownup table.
Hi, my name is Robert and I'm currently developing a site about mortgaging, and I hope you can find time to drop by. It has interesting information about mortgaging, like mortgage Quote.
Less than 1% of outstanding payment-option arms will reset this year, according to a new report issued by Greenwich Capital. Greenwich analyst Desmond Macauley calls the reset or "recast" figure "negligible." However, Greenwich predicts that next year 8% of POAs will reset and in 2009 and 2010 the figure spikes to 29% and 45%, respectively
Less than 1% of outstanding payment-option arms will reset this year, according to a new report issued by Greenwich Capital. Greenwich analyst Desmond Macauley calls the reset or "recast" figure "negligible." However, Greenwich predicts that next year 8% of POAs will reset and in 2009 and 2010 the figure spikes to 29% and 45%, respectively
This is why housing bubble takes so long to unwind. Looks like arm problem will hit at the worst possible time - we'll be deeply in recession, hoping for recovery and then ups - banks will start popping one after another.
Can you tell me if margin requirements could be raised for those banks in the meantime to force them to disperse or refinance those loans?
I'm always afraid that feds could be too political to push problems until 2008 elections.
The only super senior i know of is Christopher Reeves,and I think He died of Parkinson's.If Sebastian thinks these posts are difficult to understand he should try Ebonics sometime.and that Troll who thinks they still have chicken farms in Petaluma clearly hasn't been there for a least 10 years.It is full of chi-chi shops and overpriced mcmansions for the wannabe Marinites who like that stuff.
Hi Tanta, I've stumbled upon your site today find it very interesting. I have a quick question I hope to get your insight on: I am looking at someone who's bought subprime REMIC traches and CDOs. However, the cash CDOs are performing much better and not generating -50% market value shifts. Why is that? Is it mainly because of the grade of underlying ABS (more senior? I can't get the propects/collateral info)?
I discover that I was exaggerating terribly in certain comments above. I just went to check the ultimate pricing of the deal I used in my example, and the Super Senior came in at 21 bps over LIBOR, not 10 bps.
Forgive me for being wrong about my estimate of the price. These investors are being paid handsomely.
What I'd like to know is what percentage of MBS issuers and buyers are using spreadsheets to keep track of these things and the fluctuations in value thereof versus some more robust risk management software(i.e. database with frequently updating recalculations). I just have this nightmarish vision of a giant spreadsheet with a hundred linked tabs and formulas linking all over the place. I think that if you're using spreadsheets you would have a real hard time keeping up when things get volatile...
Very informative. I am not sure that all the holders of these types of securities would be happy to read this, but my feeling is that one is always better off knowing. I think the releases on the downgrades on bonds become a lot clearer for most people after reading this.
I am not sure if it is clear that the snowball nature of quick defaults on a mortgage pool can actually be magnified by deep tranche structures. If the initial assumptions are off by too much, the same structuring used to grade up parts of the security can become an assurance of significant principal loss for some of the lower tranches.
It would be nice if you would put a link on top of the post to parts I & II. Maybe, by a kind fate, some pension fund investor might happen across this. You never know whose retirement you might be saving!
"get there eventually"? It's sat. a.m. & you've already worn ME out. Have a great weekend, I'm going house looky-looing. It's a hoot to listen to SoCal realtors explain that anti-housing media bias has created enormous buying opportunity.
You are a wise woman, MOM.
So: An investor can choose an AAA-rated MBS, such as an agency pass-through, backed by high-quality mortgages. Or the investor can choose an AAA-rated tranche of a REMIC, paying higher interest, backed by lower-quality mortgages. Supposedly both carry similar levels of risk, as the rating implies. Apparently, the difficulty of restructuring the REMIC if things went awry never went into the calculation of a credit rating. Also notable is that in the example given, the top three tranches received AAA rating even though their initial CEs differed wildly, from 43.9% to 6.5%.
And thank you Tanta for another excellent post! You make even these extremely convoluted structures understandable to us simple mortals.
Oh, and I think your readers might find the recent Fremont downgrades very illuminating. Shoot, man, what's to worry about an 8 month seasoned pool with a performance like this:
"Series 2006-B pool 2 was structured to have growing OC; however, the OC did not reach the initial target of $23.9 million. Monthly losses have exceeded excess spread for the last three months and completely eroded the OC as of the April 2007 distribution date. Based on the performance to date, Fitch expects class B-1 to continue incurring principal write-downs."
and:
"Class M-11, rated 'BB+', placed on Rating Watch Negative. Series 2006-B Pool 2 Class SL-A affirmed at 'AAA'; Class SL-M1 affirmed at 'AA+'; Class SL-M2 affirmed at 'AA+'; Class SL-M3, rated 'AA', placed on Rating Watch Negative; Class SL-M4, rated 'AA-', placed on Rating Watch Negative; Class SL-M5 downgraded to 'BBB-' from 'A+' and placed on 'Rating Watch Negative'; Class SL-M6 downgraded to 'BB-' from 'A' and placed on Rating Watch Negative; Class SL-M7 downgraded to 'B' from 'A-' and placed on Rating Watch Negative; Class SL-M8 downgraded to 'C' from 'BBB+' and assigned a distressed recovery (DR) rating of 'DR6'; Class SL-M9 downgraded to 'C' from 'BBB+' and assigned DR rating of 'DR6'; Class SL-B1 downgraded to 'C' from 'BBB' and assigned DR rating of 'DR6'."
Pool 2 is second lien; Fremont's servicer rating is now RPS4. Gives you a warm cozy feeling, doesn't it?
Hi Tanta,
I'm a big fan of yours. I'm following Annaly Capital Management (NLY), a REIT that mostly invests in MBS. As I'm new to MBS, your MBS for UberNerds helped me a lot. Thanks a lot for that!
Their portfolio is made up 75% by GSE MBS, which are divided like this:
20% ARM pass-through certificates
72% fixed rate pass-through cert or CMOs
8% ARM CMOs
It's is according to them a pure yield curve play. Many of their holdings lost value, which didn't impact their earnings, as they claim it does not affect them as they intended to hold those securities for the long run.
Although, they are very leveraged 10.4:1 and depend on the value of their MBS to be able to keep on borrowing in order to buy new MBS. Am I correct in assuming that it will hurt them? If the MBS lose value, doesnt it imply that the rating was not accurate?
About the "yield curve play" what puzzles me is that any relatively big movement in the interest rate will hurt them. If rates go up, more people in the ARMs will face default (that looks like a prepayment to them as their are GSE). If rates go down, borrowers will refinance (which will look like a prepayment too).
Am I looking this right? Any thoughts are really appreciated as I feel kind of lost with this one.
Thanks,
- Julia
Abe, the part that gets to me is that nobody wanted the plain vanilla AAA MBS because its cash-flow characteristics were too unreliable. The GSEs only protect you from principal loss; they don't protect you from prepayment risk. So all this fancy tranching is also supposed to help you hedge your prepayment risk. Ooops! Don't pay any attention to what that did to your credit risk . . .
I'm also entertained (in the usual sick way) over this "super senior" business. If anyone can find an actual credible definition of "super senior," pass it on, I'd love to know. As far as I can tell, it's just a way of pretending that that top tranche is "really" AAAA, not AAA. (Of course there's no such thing as an AAAA rating.) But I do wonder if there are people who think that you can actually do better than getting repaid. I just hope they aren't in the mortgage business.
Am I correct in assuming that it will hurt them? If the MBS lose value, doesnt it imply that the rating was not accurate?
It's hard to say without knowing what their cost of funds is.
And remember that GSE MBS never get downgraded. They are always implied AAA. They might lose market price, because they yield less than a new bond, or they might get so old (so prepaid) that they don't yield much, but they don't get downgraded. You can, if you're an institution, hold them to maturity without worrying that you'll have to unload because the rating went down.
The ugliness with some of these senior REMIC tranches is that someone, like an institutional investor, who has to have that AAA on its investments might have to unload, at a bad time, just because the rating went down.
I honestly don't know enough about Annaly to have a worthwhile point of view about its hedge on all those fixed rates.
Tanta,
the AAAA rating was developed, for your knowledge, approximately 12 months ago by private equity, they instituted the AAAA rating as a way to label the bonds that they would need to take out and pay handsome premiums to do so (regardless of prior rating) before they turned them into deep junk in order to remove the existing covenants.
(tongue in cheek response of course)
risk capital, maybe it's an "AAAAArms Race." You know how much these masters of the universe like to get into pissing contests. "Oh, so you issued some weaselly AAAA Super Senior? Well, Jack, I'm issuing an AAAAA Super Duper Senior. Worship me."
And so on.
Can someone comment on the new FHA expansions and if this is enough to re-spike the punchbowl?
Here are comments from the head of the FHA:
"I think we have some better solutions to the problem, both short-term and long-term. We can re-ignite the housing boom if we are prepared to make some important changes."
HUD News Release 07-050
Here is a summary of the new bill:
House Financial Services Committee
BTW, sorry if this is off-topic, I am just really worried about this. I know you guys know alot about the biz, thanks.
Perplexed, I promise I will do an intelligible post soon on the FHA "reforms." To be honest with you, finishing the current installment of MBSopedia used up most of the spare brain cells I had this morning, and my next trick is to find the most irritating YouTube out there for Saturday Rock Blogging. I know that says something about my priorities that I should be ashamed of, but I'm just a mortgage banker. We're punks. Get used to it.
So everyone will have to settle for "I think 99% of FHA reform proposed is DSM-III level insanity," for now.
The permabear mentality:
1 Bears don't have to compete with the larger number of "bulls" who tend to be right, by varying degrees, some "95% of the time." The market is up, on average, 8-10% a year leaving the permabears shoveling shit in Petaluma 95% of the time.
2 Forget the facts, fear sells even bigger.
3 Bears don't keep score based on performance results (that would put them out of business in a heartbeat), he keeps score by the amount of fees he can generate.
4, There are always enough fools and investment pigmys out there to make it worth his while to peddle his brand of snake oil. Likeminded financial morons travel well together.
5 Bears arent investment guys, theyre marketing guys (snakeoil peddler) with a flim/flam niche.
6 Bears are focused on yesterday because its easier than being focused on the future. If you notice, they spend an inordinate amount of time analyzing, agonizing over and discrediting both the reported data and/or the sources of that data. Real investment guys look forward and don't drive their portfolios looking in the rear view mirror.
7 Most good money managers tend to be optimistic (because of #1), PermaBears are always pessimistic.
Its always very easy to spot those financial pigmys and investment dwarfs who have not participated in the last 5,200 points of the market rally.
Tanta, it looks like someone shoved a live snake up your ass over on the other thread. Don't get to uppity, girl, or your covered parking priveledges will be revoked. Capiche?
GOOD MORNING WART DOCTORS...
Your role is to constantly re-energize the "wall of worry" needed for bull markets to climb. Loading up with puts at market bottoms also helps; you have yet to let us down.
In contrast, my role is very different. My job is to make money--bushels full of money.
Keep up the good work WART DOCTORS...so far, so good! I knew that I could count on you--again!
Let's face it, some folks were put on this planet to produce wealthy families...others are here to shovel shit in Petaluma.
So, "Bears," did you steal that from this commenter at Kudlow's blog? Or are you the same commenter, but not willing to use the same handle on this blog? And where did you get the idea that we care about your comments to a Kudlow post?
Kudlow's Money Politic$: Good Friday Blockbuster
"AMERICA'S BEST YEARS ARE BEHIND; WE MUST LEARN TO REDUCE OUR EXPECTATIONS."
Perplexed said: "BTW, sorry if this is off-topic, I am just really worried about this..."
Tanta, congratulations on your latest successful conversion.
Now, how do we know when all this will come home to roost? How will we know if it comes to roost?
You've shouted "FIRE!" in a crowded theatre, while ignoring the fact that there's a sprinkler system installed and fire extinguishers available. Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?
Sebastia
INFLATION IS TAME, JOBS ARE PLENTYFUL, STOCKS ARE BOOMING, WEALTH IS SURGING AND CONSUMERS ARE CONSUMING...
Life is good, America is blessed with abundance!
OUR CUPS RUNNETH OVER!
....AND BILLY THE ANONY DOOM BLOGGER HERE WILL SOON CANCEL HIS RECESSION!
My glass is not half-empty...its filled to the brim with Makers Mark!
"...or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?"
WAKE UP, BUTTERCUP!
These are angry, lonely, passed-over, under-achieving, life long middle manager's here who are capable of cubicle duty and can see within those four padded walls - but no further than that.
Anony blogging fear mongering is their one and chance to role-play the part real life has cheated them out of.
These financial simpletons spend their entire day discrediting all financial reports that disagree with their forever-wrong case or discrediting the source of the reports. (And when theyre not doing that, theyre monitoring the blog, deleting all those "trolls and assholes" who visit it). But when it comes to their always-wrong projections, they can't do that so they simply bring up all sorts of fabricated qualifiers--"I really didn't say that, this is what I really said," bullsh*t.
Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?
Sebastian, I'll pass over the "difficult to understand" part. If you can't follow this, you shouldn't be investing in mortgage-backed bonds. That's all. That is not shouting "Fire." That is suggesting that your risk tolerance has been exceeded if you don't know what your risk is. Investment 101.
But where do you get "impossible to verify"? There's a giant internet out there, Seb, and it's chock-full of information from hundreds of sources. Fact-check me, kid! Go to it! Go to U.S. Securities and Exchange Commission (Home Page)
and download some prospectuses! Read every methodology paper on the rating agencies' websites! Hit the Bond Market Association, the American Securitization Forum, and the Hudson Institute! Pick up the phone and call industry experts in the MBS trade and ask them to review the document! Go nuts! You want to evaluate my credibility? It's so easy to do! Just do some work.
But until you have done that, please do not confuse "I cannot verify your facts" with "Your facts cannot be verified."
We have had occasion before now to remind you of the difference between something you don't understand and something that is wrong.
PERMABEARS AND FINANCIAL PIGMYS...THIS IS WHAT WERE FIGHTING AGAINST:
...despite all of the permabear poop, the OECD core CPI inflation rate has remained remarkably stable between 1%-2% since 2003. Thats because all those relatively scarce (high priced) commodities have been converted (by cheap labor) into a glut of (low priced) consumer goods. Global competition has forced manufacturers to increase their productivity to offset rising materials costs since they cant raise their prices.
Permabears are trapped in a 1950s intellectual hammock.
It is not so much shouting fire in a crowded theater as passing out bulletins that it may catch fire.
In any case, why do bulls, exp the newly minted variety, so worried about the bears, after all for every buy, there has to be a seller.
In any case, it is a psychological thingee that folks that have just bought to be bullish. Has little to do with logic.
Hey Permabears,
Globalization is eating your lunch faster & faster every day--and the whole planet is getting richer...just hold your breath and make it go away.
It started before Subprimogasm and you think that your pathetic and failed bubble theory, anger, hatred, foaming at the mouth, bitterness, envy, victimology, unaccountability, non-responsibility, unpatriotic anti-Americanism, whinniness, pissiness, moaning and self-loathing and moonbattery will make it go away?
Isn't it fascinating, Vader? I mean, I'm loving all this "middle manager" stuff. Where's that coming from? The belief that only CEOs have insights? Or that people who have a discount brokerage account and watch Kudlow have a point of view worth listening to, but people who, oh, manage brokerages don't?
These guys claim to be such loyal patriotic Americans, but it seems to bother them to no end that not everyone is forced to agree with them, and that actual middle managers are allowed to use the internet, which I guess these guys think should be restricted only to the superior class. I guess they think that productivity and corporate earnings will rise only if workers and middle managers are muzzled and silenced, and that recycling someone else's work is "production." And yet they wonder why the rest of us don't want to take their bets . . .
Hey Permabears,
Globalization is eating your lunch faster & faster every day--and the whole planet is getting richer...just hold your breath and make it go away.
It started before Subprimogasm and you think that your pathetic and failed bubble theory, anger, hatred, foaming at the mouth, bitterness, envy, victimology, unaccountability, non-responsibility, unpatriotic anti-Americanism, whinniness, pissiness, moaning and self-loathing and moonbattery will make it go away?
HOLD MY POLE MONICA, WE'RE GOIN' FISHIN'!
All-time record high earnings and earnings gains that beat expectations, low interest rates, low inflation, world economic growth pushing a bodacious 5% annual rate, 4.5% unemployment...combine that with stocks that are nearly 30% undervalued v. bonds, record put buying of a few weeks ago, record global liquidity and a multi-billion $dollar "deal of the day" and you have the makings for GOLDILOCKS BABY!
Stocks are undervalued compared to bonds by some 25-30%, its been over 25 years since we last saw such a huge valuation gap, a gap that ALWAYS gets closed. And since we used so little financial energy moving that "CotD" dot up to the "best-fit" normal line to date, we still got a lot of ooomph left in the tank to get there.
THE GLOBAL MELT-UP WONT QUIT
Warren Buffet - king daddy permabear:
Buffet Warns of Dangers of Derivatives
OMAHA, Neb. -- Billionaire Warren Buffett repeated his warning that the growth of derivatives and excessive borrowing by traders, investors and corporations will eventually lead to significant dislocation in the financial markets.
In fielding a question about derivatives, which he once referred to as "financial weapons of mass destruction," Mr. Buffett told some 27,000 shareholders at the annual meeting Saturday of his Berkshire Hathaway Inc. holding company in Omaha that he expects derivatives and borrowing, or leverage, would inevitably end in huge losses for many financial participants.
World According to Buffett - WSJ.com
DISASTER...CASTROPHE..GLOOM & DOOM:
There was a great global economic boom during the 1950s and 1960s, but it was limited to the postwar reconstruction of Japan and Europe, and the transformation from a war-time to a peace-time economy in the US. Many economists predicted a depression would follow the end of World War II. Instead, there was a great postwar boom, but the resulting rise in standards of living was enjoyed by maybe 500 million people. Today, at least 3 billion people are prospering, especially in the emerging nations. Prosperity, however, is not a zero-sum game. So prosperity in Asia, the Middle East, Eastern Europe, Russia, and Latin America is providing lots of stimulus to the industrialized economies. Ah yes, 3 billion new customers compared to a total EU population of only 450 million.
The way it looks now, the current world wide economic boom could easily last for many more years-maybe even decades. With expensive raw materials being converted into cheap consumer goods by an abundance of inexpensive labor (that 3 billion mentioned above), inflation looks more like TAPIOCA than any real serious threat. Interest rates will remain historically low for the foreseeable future. Capital will rapidly migrate to where it is treated best.
THIS EQUITY MELT-UP WON'T QUIT.
Look who's actually foaming at the mouth. And let's not feed the troll.
The American Enterprise Institute (yeah, I know, but their banking analysts are pretty good) held a Subprime Seminar last March 28th. At the beginning of the Q&A Chris Whelan responded to a question by Bert Ely and made an interesting remark on enhancement. I'll be posting with a transcript of that exchange in a few days, but for now here's the bit that relates to today's topic.
Sebastian, you wrote: "You've shouted "FIRE!" in a crowded theatre, while ignoring the fact that there's a sprinkler system installed and fire extinguishers available. Now what's your advice to the crowd, or is frightening people with difficult to understand and nearly impossible to verify information the limit of your responsibility?"
The idea that Tanta's information is just wrong or impossible to verify is refuted by the wave of downgrades on MBS bonds lately, federal regulatory agency warnings to banks, SEC filings, etc. Her information is very easy to verify.
I really do not understand where you are coming from on this one. You seem to define "irresponsible" as "telling the truth". The entire financial regulatory structure places great value on disclosure of information to any prospective investor. The idea that explaining investments in plain English is somehow "irresponsible" is risible; it is in fact a statutory requirement.
The only thing Tanta has done with this post is provide the average person with the ability to read and understand a downgrade, affirm or negative watch notification from a firm like Fitch. If you are objecting to that, you have a heck of a problem.
As for sprinkler systems, etc, those who have already incurred principal losses would disagree that these systems were in working order. It is extremely unpleasant to find your As turning to Bs or Cs, granted. If you want to blame someone, blame the originator, securitizer or the ratings firm, not the person who is explaining what all this stuff means.
"The market can be an expensive place to find out who you are."
The market is the best barometer of the planet's collective wisdom at any given time. And like most barometers, it is also subject to change. And it is forward looking. When you think that you know more than the market or have a better forward looking barometer, then you are headed for a big fall. You are right and the market is wrong. Exactly why Permabears bring no added-value to the table--the sky is always falling and the glass is always half empty. They never get close to seeing the "Big Picture. They just discovered the abundance of global liquidity and global savings glut after a 6000 point advance in the DJIA.
BEARY BAGHOLDZ is another similar animal--he too can't deal with the future and how that market barometer can change. They drive their investment vehicles looking in the rear-view mirror and are always in crack-up mode.
THE LONGEST BULL RUN IN 80 YEARS
Thanks for that little tidbit, John M. I have to agree that if AEI is worried, I'm worried!
This is HIDEOUS. Can't someone stop this assault of positive postings? Can't they be subpoena'd and sued?
We have certain rights and we can't be subjected to this BATTERY! It's INHUMAN.
Just like the rest I come here to read things that reinforce my world view and it's my right and entitlement to not have to read things I don't like.
Has anyone notified the proper authorities for Godsake?
All caps, the last refuge of permatrolls.
I am first of all baffled as to how Tanta's post can be considered either "bearish" or "irresponsible." I see an industry insider describing how the industry works. She is, as always, quite careful to limit her conclusions to the data.
Second, I'm trying to understand the conflicting interests of the tranches given what you've said, Tanta. Let's say that a lot of the loans in a particular pool start going belly-up. Is the problem that the Super Senior trancheholders are OK with this so far? That the problems have to get really bad before they start getting affected, so they don't want to be deprived of the loss of income that would result from a massive number of modifications?
On the other hand, would the Toxic F- trancheholders badly want to see the loans modified because as things stand, they are going to get nothing, and anything is better than that?
Am I off-base? Apologies in advance for any terminology misuse. . .
Well since the economy is doing so great... let's continue the rise of the interest rates! Certainly the strong economy can handle it. You're not begging for rate decreases are you?
Tanta,
My boss just had to write a white paper for some company's credit deriviatives holdings. He had to make assessments on the risk. This guy is super smart and I think his head was ready to explode.
I don't see how the price can be priced effectively in this current marketplace of unknowns. With time, the market will figure it out. Until then?
ac,
Buffet was the first to warn on derivatives and use the term "financial tools of mass destruction",
one might ask themselves why arguably, the greatest investor of all time, is sitting on boatloads of cash?
I'll answer the question for you, due to his belief that things are grossly overvalued.
I will also venture to guess that he is quite concerned about the eventual end game in the current wave of LBO's and PE deals.
But, we know one thing for certain....
the regulators and the Fed governors will most certainly proclaim that the problems are "contained" and "we aren't seeing any spillover".
We may even, at that point, get headline Fed governor quotes every thirty minutes throughout market hours.
For all the conspiracy theorist lurkers...
ever think the 500 pt Feb. drop was a test of the system?
For me, reading this blog's posts and the comments thereon is like attending a seminar in which I can hear and participate in discussions among civil, intelligent and serious people. Having some civil and serious dissenters such as Sebastian, banker, and Steve in the group is useful, as they stimulate debate.
When Sock Puppet heaves into view, however, I feel as though a perverted, syphilitic lunatic screaming filth at the top of his lungs has barged into the seminar room.
Let's say that a lot of the loans in a particular pool start going belly-up. Is the problem that the Super Senior trancheholders are OK with this so far? That the problems have to get really bad before they start getting affected, so they don't want to be deprived of the loss of income that would result from a massive number of modifications?
You're doing fine with the terminology, Amadis. I haven't seen a lot of F tranches, although there are really things called "Z bonds," so never think parody can get ahead of reality.
The thing is, basically, that unless the pool is just ungodly unbelievable worthless junk, the senior note holders are never going to lose any principal. There have been some very bad securitizations out there where senior notes have lost money, but I still think most of them will not take a write-down.
The trouble for the seniors is two-fold:
Think about it like foreclosures: you are most likely to have to foreclose at the time when property values are dropping. You don't tend to have to foreclose when houses are appreciating every day and so your REO might be worth something.
This is the market mechanism that the securitization structure didn't "solve." I do not claim that every bond salesman claimed to have "solved" this problem, but a whole bunch of them have acted as if they did.
Amadis,
Tanta's article uses easily verifiable facts relating to market mechanisms and draws no conclusions and therefore, cannot be irresponsible.
That poster is an older version of a babbling know-it-all teenager. He also posts bragging about his latest master day trade, etc.
Saw this on Yahoo!.
Yahoo! 404 - Page Not Found
Is this the "tapped out consumer" we are betting on?
St. Louis Fed: Series: PCECCA, Real Personal Consumption Expenditures
And the residential investment Rapture that will sink the USS Economy?
St. Louis Fed: Series: PRFICA, Real Private Residential Fixed Investment
Oh, MY!
We should be grateful for market participants who base their decisions on catchy patriotic american slogans. They are a rich source of exploitable market inefficiencies. Sadly, this sort have only nugatory means to piss away. They seek only to please their betters and on Monday (they have no private income) they will be kissing asses for preferment with the characteristic unctuous deference of their class.
The Industrial Age peaked out around 1965 (40 years ago), and manufacturing has steadily declined as a percent of GDP every year--even though in absolute terms manufacturing hits a new all time record high each and every quarter. The 20th Century Industrial Age replaced Agriculture over 100 years ago, when 50% of all jobs were on the farm. Today its 3-4% and going to 1%--and we now feed the world!
The Information Age/Service Economy (Technology Age) did likewise to manufacturing 40 years. Low paying, blue collar (union) jobs at the plant, factory, foundry and mill requiring little education and skill (labor) have been replaced by higher paying professional jobs (involving intellectual property) requiring more skill and education in the areas of medicine, engineering, law, education, financial services, etc., etc.
Joe 6 Pac and union laborer have been replaced by Wong and Vishnu abroad, just like Joe 6 Pac replaced the Buggy Whip guys in 1905. Education and brain power has replaced long hours and a strong back as the primary requisite for success in today's modern and increasingly globalized economy.
And American wealth, prosperity are hitting new highs every year and we are all enjoying a higher standard of living as we live longer and healthier.
Bottom Line: Put that buggy whip, plow, shovel and hammer down and get your ass into a classroom where you can secure a relevant position in today's modern economy. Either that, or you'll be shoveling shit in Petaluma for the rest of your life.
BUT THEN AGAIN...
SOME FOLKS WERE SIMPLY BORN TO SHOVEL SHIT IN PETALUMA...AND MAYBE EVEN ENJOY IT.
Funny Circus Bears
"get your ass into a classroom where you can secure a relevant position in today's modern economy."
No, I think I'll just sit on my ass and day trade.
Where is my job? Where did all the jobs go? When I entered college code monkys were banking signing bonuses and 100k per year salaries plus stock options. Now little brownpeople in Bangalore are doing my job for $1.65 an hour. You owe me. I'm entitled.
http://i12.photobucket.com/albums/a216/Pixbucket/jobs070504a.gif
I am entitled to the right to have what I want, when I want it, and I want things to change NOW.
Education. Skills. How quaint. First one must compete for the chance to rub elbows with one's betters at the finer schools. Failing that - my condolences - a bit of occupational training can mitigate the hardships of one's caste.
CR: OFF THE CHARTS; A Car-Sales Indicator Suggests a Recession Is Near or Already Here - New York Times
Is this the median home price trend that is going to cause the "housing led recession"?
http://i12.photobucket.com/albums/a216/Pixbucket/US20Median20House20Prices2.jpg
And BTW, that graph needs to be updated to reflect the current price which is North of $250k - OFF THE CHART.
I am a simple minded guy. Almost every day I see in the grapevine those morgages request that can not be paid back. Not all, just a few but they are there.
Why are lenders giving away this money that could not be paid back ? How is this whole MBS thing allows them to recover from such mistakes ?
Can't somebody please make him stop?
We have a right to data mine and cherry pick negative "facts" and draw a straight line conclusion to our predetermined doom scenarios without seeing the actual positive reality. We like to and it's our right.
Where's that subpoena guy or Taxta to legal action here?
My rights are being trampled on, I feel violated, dirty even.
This is now:
http://i12.photobucket.com/albums/a216/Pixbucket/07-04-13_SoCal_RE_Price_Small.png
This was then:
http://i12.photobucket.com/albums/a216/Pixbucket/90sbustreal.jpg
When will we get our way? We have that right!
Is this showing our housing led recession?
http://i12.photobucket.com/albums/a216/Pixbucket/OFHEOQ1.jpg
I'm holding my breath until I get my way!
Here's my favorite book, which I'm sure you all have already read:
http://i12.photobucket.com/albums/a216/Pixbucket/0890513406_01__SS500_SCLZZZZZZZ_V10.jpg
Bring on The Rapture!
Facts. Reality. Very good. Your fervent acceptance of our meritocratic doxa will reconcile you to your lot in life.
"When I entered college code monkys were banking signing bonuses and 100k per year salaries plus stock options."
Aww c'mon Tremulous Timmy, AKA Bear Scat and all the other handles, now we know you're lying. You haven't entered college yet; maybe a sophomore in high school at most, probably w/o many friends, a bit closer?
You can't do better than a cheap dialup connection but since that means your ISP gives you a different IP address from its available pool each time you log on at least you're harder to block when you become a pest; a bit closer still?
How about you got busted for plagiarism at school and are spending a lot of time in your room, fooling around on the internet cutting and pasting stuff while trying to get a rise out of people when the parents aren't home; even closer yet, hmmmm?
You've never invested in anything other than your right hand have you? C'mon kid, give it a rest; you're not fooling anyone here.
Mish highlighted Caroline Baum's article, but, this quote is classic,
"Imagine how it would look if Congress were to ask him to explain why the Fed let the economy slip into recession with inflation so low. Would Bernanke be able to keep a straight face when he told them that GDP ex-housing was solid?
Heck, GDP excluding consumer spending, business investment, housing and exports was robust in the Great Depression, too."
Housing? What Housing? I Don't See Any Housing: Caroline Baum - Bloomberg.com
Tampta or that Subpoenaboy guy needs to FOLLOW THRU with the threat of legal action. IT"S OUR RIGHTS that need protecting here.
Let's get everyone out in the open, take depo's, examine the backgrounds of all interested parties, and have our day in open court.
That's a GREAT IDEA. Why didn't I think of that?
Reading your description of pass-throughs, REMICs, traunches, and evermore complexity piled on complexity, I am struck by the question: "Does everyone involved have the accounting systems in place and the sophisticated staff to accurately track this stuff?"
I suspect that accounting clerks who are inputting the data don't understand what all the variables and fields they are populating mean. Their managers might be masters of debit-and-credit algebra, but if they could do calculus and advanced statistics, they would be actuaries. They traders might understand the math, but their willingness to translate it into accounting probably ends when they are comfortable that the bonus measurement module when give them the answer (think Joe Jet and rollovers).
In short, everyone is fooling themselves that they have an accurate measure of what is going on. It is the "unknown unknowns" that will get them, plus cluelessness about these unknown, unknowns so everyone keeps playing double-down.
Is this the "tapped out consumer" we are betting on?
And the residential investment Rapture that will sink the USS Economy?
Oh, MY!
Tremulous Timmy |
Timmy, great examples of lies, damn lies and statistics with you St. Louis fed sets:
The PCECCA series(as a % change from previous year) peaked in 2004 and has been sliding ever since.
The PRFICA series (as a % change from previous year) also peaked in 2004 and started falling off a cliff in 2005.
What does all this mean? That there's weakness in the system. Is that alone enough to put us over into recession? No.
But these data sets aren't in a vacuum.
Asides from oil and heavy equipment, what other industry truly is healthy?
Retail: weak
Tech: weak
Auto: weak
Transports: weak
Builders: weak
So unless we've become a nation of online shopkeepers, this blowout in the stock market makes me wonder why it's happenening.
And as for parroting Larry Kudlow, I'm still waiting for his $20 barrel of oil prediction(pre Iraq war) to come true.
""The introduction of derivatives has totally made any regulation of margin requirements a joke," said Mr. Buffett, referring to the U.S. government's rules limiting the amount of borrowed money an investor can apply to each trade. "I believe we may not know where exactly the danger begins and at what point it becomes a super danger. We don't know when it will end precisely, but ... at some point some very unpleasant things will happen in markets."
World According to Buffett - WSJ.com
lennar in trouble in san fran
SAN FRANCISCO / Condo owners upset by work done by builder / Lennar Corp. is working on 2 city projects, in line for 1 more
Subprime defaults made worse by securitization: Buffett
By Barbara Kollmeyer
Last Update: 1:34 PM ET May 5, 2007
OMAHA, Neb. (MarketWatch) -- Rising defaults in the subprime mortgage business have been exacerbated by securization of these loans, Berkshire Hathaway Chairman Warren Buffett said on Saturday during the company's annual meeting. Subprime mortgages are offered to poorer people with blemished credit records. The loans are often packaged up and sold on again to investors as mortgage-backed securities. "Once you package those things and sell them through major investment banks, discipline leaves the system," Buffett said. Subprime borrowers have been missing their first and second monthly payments recently, he noted. "That shouldn't happen. Securitization has made the problem worse," he added. A slowing housing market has triggered turmoil in the subprime mortgage business this year. Legislators have been discussing possible new regulations to deal with the crisis, including making investors in mortgage-backed securities more responsible for future delinquencies.
Subprime defaults made worse by securitization: Buffett - MarketWatch
"...including making investors in mortgage-backed securities more responsible for future delinquencies."
This seems poorly stated by the reporter -- how could an investor be responsible for a default rate -- but sure, why not, it should be the responsibility of any investor to read the prospectus w/ acceptance of risk an inherent part of that process.
However, even though I suspect legislators would love to leave investment banks -- major political contributors that they are -- entirely free of liability for the products they produce I suspect the net result could be an increase in the cost of mortgages to the end-borrower unless developers of MBS synthetic products are also held responsible for the structure of the loan pool therein.
JMO
RW, I think the reporter had been told something about HOEPA loans. Purchasers or assignees of HOEPA loans inherit all claims that could be made against the originator, and are bound by the same restrictions as an originator. This liability pass-through was necessary to prevent evasion of the purpose of the law. Without it, a loan could be written, sold, and then the borrower could be victimized with no legal liability. Financers could simply sell these loans back and forth and bypass the rules.
It's questionable whether a subprime originator, purchaser or assignee writing a low fee loan at 7.5% should be bound by the same rules.
On the other hand, neg-am consumer purchase mortgages, should, IMO, be subject to similar rules. The way that many of the current neg-am (Option ARM) loans are structured, the consumer winds up paying interest on interest. This may well result in the same sort of equity stripping and constant under-the-gun refis that HOEPA was originally written to block. This is equity stripping in its purest form.
If you take a look at some of the newer products, some of them turn into HOEPA-like loans later on. HOEPA does not cover loans which have lower stated interest rates at consummation, but when you start charging interest on interest it mounts up quickly. When offered to unsophisticated borrowers such as Amadis of Gaul's friends, the end result can be very similar to the type of situation for the borrower HOEPA was written to prevent.
In addition, many states have legal provisions limiting recourse against consumers for purchase-money mortgages. Writing a loan that will force a refi before reset or shortly after essentially strips the borrower of this protection.
There is more to HOEPA than this, but Title 12 226.34 will give you an idea of how the liability pass-through works. Needless to say, the end market for HOEPA loans is limited.
Jim R, Lennar has similar problems in Florida.
Hey! No discussion of why build-to or fully-funded o/c is used when a deal is structured? U are slacking!!!
Also, many people are way too dependent on the rating agencies, in my experience. S&P made changes to LEVELS! Oh no, there go whole loan prices!!!
How about an uber-nerd on NIMs next?
Thanks Tanta for an eye-opening explanation of the derivatives market. Should be interesting to see just how the Law of Unintended Consequences kicks in through the coming years.
Who is so inasne to still do thse kind of loans:
Mortgage Grapevine: CA, $1,600,000, 620 FICO, 85% LTV, Refinance, SF, bkstat, OO
The person have already missed a payment. can not doc his income. Has low FICO score but neds cash out on a $1.5M home. (when was the appraisal done ? is the house still worth $1.5M - maybe it is only $1.3M by now ???)
The person wants a neg-arm meaning he ca not really pay the cost of this home but for a minimum pay of the teaser rate he can stay for two more years at this home.
Anyone really think this will not end up in default ????
You got to love this:
House paraised by 10K more than the recent purchase price - quick do a cash-out HELOC:
Mortgage Grapevine: Can anyone do a Heloc at 632 score?
I don't know about your skepticism on super senior tranches Tanta. It seems to me that come '08-'09 the difference between 43.9% CE and 6.5% CE could be a useful one.
It's not so much yelling fire as giving a short description of the fire code, including a discussion of the number of fire doors, time to exit, and presence of sprinklers.
I don't feel so much that this is a seminar that I've been inveted to as that this is the first time that I've been able to eat at the "grownup table" at Thanksgiving. I'm trying hard to follow the conversation even though I'm out of my depth. I'm learning alot and can occasionally say something that adds to the conversation, so I'm quite proud of myself, and feeling like I'm one of the "big kids" now. The fact that they've also let my spoiled, screaming four-year old cousin sit with us rather detracts from my joy. Getting away from him and his food flinging was supposed to be one of the joys of this thanksgiving.
I should have ended the second paragraph with, "And now, I want you to welcome our band for the night...GREAT WHITE."
Now that David Lereah has to sell his house and move to CA, what kind of loss is he going to take? Especially since he bough it just last year.
I don't know about your skepticism on super senior tranches Tanta. It seems to me that come '08-'09 the difference between 43.9% CE and 6.5% CE could be a useful one.
Certainly, if these puppies are still around in 08-09, that super-dooper CE will be handy.
But who the hell wants to earn 10 bps (or whatever it is) over LIBOR for that long?
Given what it costs just to do the accounting on this stuff, and pay the broker for it, I'd be inclined to buy treasuries. In fact, I admit, I own a lot of short-term munis. If I'm going to get "risk free" yield, I don't want to pay loads for it, and I don't want to have to hire KPMG to do my tax returns. (Like that would help, but still, I would be expense.)
I'm just a mortgage punk with a bad habit of watching out for nickels and dimes: you get that kind of training in the prime conforming market, because it's all nickels and dimes until its jillions, but the jillions don't tend to be gains.
So someone else will have to explain where the "super senior" becomes the value play. It looks to me like no risk and no return. You know, like eating candied sweet potatoes with marshmallow topping. As long as you bring the casserole to the boiling point for at least 20 minutes, the germs won't kill you. But then you have to eat it. In my view that takes a bit of the fun out of being at the grownup table.
Hi, my name is Robert and I'm currently developing a site about mortgaging, and I hope you can find time to drop by. It has interesting information about mortgaging, like mortgage Quote.
Let me now what you think.
Hi Robert,
Speaking for myself, I think I don't like spam. Have a nice day.
Bob, Bob, Bob....
mistake Bob, bad, bad, mistake.
Tanta is on her way to your primary residence as we speak, you're worm-spit, Bob.
Oh, Bob, you did not just spam Tanta's thread, contact Haloscan now Bob before she gets into your driveway.
Less than 1% of outstanding payment-option arms will reset this year, according to a new report issued by Greenwich Capital. Greenwich analyst Desmond Macauley calls the reset or "recast" figure "negligible." However, Greenwich predicts that next year 8% of POAs will reset and in 2009 and 2010 the figure spikes to 29% and 45%, respectively
NEWC: "it was extremely difficult to validate the assumptions
it used in determining its gains from ..securitizations."
This is why housing bubble takes so long to unwind. Looks like arm problem will hit at the worst possible time - we'll be deeply in recession, hoping for recovery and then ups - banks will start popping one after another.
Can you tell me if margin requirements could be raised for those banks in the meantime to force them to disperse or refinance those loans?
I'm always afraid that feds could be too political to push problems until 2008 elections.
The only super senior i know of is Christopher Reeves,and I think He died of Parkinson's.If Sebastian thinks these posts are difficult to understand he should try Ebonics sometime.and that Troll who thinks they still have chicken farms in Petaluma clearly hasn't been there for a least 10 years.It is full of chi-chi shops and overpriced mcmansions for the wannabe Marinites who like that stuff.
Hi Tanta, I've stumbled upon your site today find it very interesting. I have a quick question I hope to get your insight on: I am looking at someone who's bought subprime REMIC traches and CDOs. However, the cash CDOs are performing much better and not generating -50% market value shifts. Why is that? Is it mainly because of the grade of underlying ABS (more senior? I can't get the propects/collateral info)?
I discover that I was exaggerating terribly in certain comments above. I just went to check the ultimate pricing of the deal I used in my example, and the Super Senior came in at 21 bps over LIBOR, not 10 bps.
Forgive me for being wrong about my estimate of the price. These investors are being paid handsomely.
What I'd like to know is what percentage of MBS issuers and buyers are using spreadsheets to keep track of these things and the fluctuations in value thereof versus some more robust risk management software(i.e. database with frequently updating recalculations). I just have this nightmarish vision of a giant spreadsheet with a hundred linked tabs and formulas linking all over the place. I think that if you're using spreadsheets you would have a real hard time keeping up when things get volatile...
Yal,
As frightening as the loan specs were, the comments were even more so. So, I'm going to get a $1.5M loan from "poniboy1@gmail.com"?