Okay, you want to read something else that is equally frightening...and that is synergistic with the Bloomberg article:
Economists, however, caution that the picture of savings isn't as bad as it looks. The savings rate doesn't provide a complete picture of household finances because it doesn't capture gains from such things as real estate or financial investments.
How does one really not think this is a fatal two-car collision in slow motion?
For young people who still live at home or yuppies who make tons of money - they mostly consume DVD, 4whellers, flat TV etc... - food/eneregy is not a big part of their expnses (or they are paid by momNdad.
For them inflation is low.
Older people: They pay for medical, food, heating, energy and less so on consumer items - for them infaltion is moderate to high.
Avg family with 2-3 kids (or even larger families, or the single parrent with 1-2 kids) who don't make much money - for them expenses are food, enerfy, education etc.. - for them infaltion is running at 10% or more.
May Disposable Income (DPI): -0.1%
May Personal Consumption (PCE): 0.1%
May PCE Price Index: 0.5%
April DPI revised down to: -0.6%
March PCE revised down to: -0.1%
Is there any analysis discussing the impact of the mortgage crises on the TOTAL value of housing stock-a $20+ Trillion dollar asset clasee?
As homes go into foreclosure and inventory builds, it not only impacts that particular house, but all the houses in the area. As the process sprials, the impact is seemingly potentially enormous.
There cannot be $800B in subprime paper held by CDOs if the entire market for subprime paper is $800B.
Remember all the uproar about Fannie and Freddie, for instance, buying subprime securities for their portfolio? Well, that'd be an example of subprime MBS outstanding that are not resecuritized into a CDO and held by a hedge fund.
In the June 27 WSJ, the Mortgage Meltdown article allowed as how Wall St. sold $508 billion in "bonds" [sic] backed by subprime mortgages and in 2006 the market softened a bit--they still sold $483 billion. Can't quite make that jibe with Bloomberg, especially #9. Also in 2006, the top 5 underwriters packaged and sold $203.9 billion of subprime mortgage backed securities. (Again, WSJ article.) It strikes me that to get to $$483 billion, there must be a whole buch of underwriters...
Real PCE is rising at a 1.3% annualized rate so far in Q2. The rate in Q1 was 4.2%. In Q4, it was 4.2%. Inventories and trade will probably add to Q2 GDP, after being a drag in Q1, but over the long haul, GDP tend to track final sales to domestics.
David, the numbers I've seen thrown around most commonly for 2006 are:
~$650B in subprime mortgages originated
~$450-$520B of those were securitized
Let's call that an even $500B in subprime mortgage-backed securities issued in 2006.
If on average the total of the BBB- minus tranches offered for sale was 20%, which is a ridiculous number, that would mean $100B of yuck tranches available for resecuritization into CDOs.
But there's no earthly way that number is 20%. The Bloomberg article notes that Lehman's total 2006 SAIL bonds had a face value of $2.43B and BBB- tranches of $18MM.
So if $169B in low-rated subprime MBS tranches got resecuritized into CDOs just last year, they're either buying old tranches or they're buying higher-rated tranches or this $169B counts a lot of credit default swaps or double-counts some tranches (perhaps the CDO squareds are being added to the CDOs?)
Or, of course, the CDOs are into prime and Alt-A mortgages that are in trouble, but we're calling them all "subprime."
As usual, the more I read the more confused I get.
Tanta asked: "...Does anyone else want to take a stab at estimating the potential principal losses that exceed the current estimated principal losses on $200B in subprime ABS, so that we have some idea of how many dollars of losses the rating agencies are "hiding"?"
Sure, what the Hell.
Take a 100% write-off of the entire $200 billion. That would be just under 1.5% of one year's nominal U.S. GDP. Or it would be about 100 days of SP500 company earnings.
Sorry if you don't like the asterisks, Tanta, but I prefer not to shout in all-caps.
Can someone explain to me what is so great about the numbers today ?
Consumption up (but not by much) , income below expectations, infaltion in check (1.9 Vs 2.0 - which is Fed maximum comfort level).
But wait: we get a new measure on infaltion every day. yesterday inflation numbers were not so good.
on the other hand AHM losses, 9.75% loan. KBH is now higher than it was before the "unexpected" losses. CFC up after the down grade. (and btw, after all the 6 month of rumors CFC did not went down after BoA said: not intersted in buying CFC)
is it just me who thinks that getting 90 points on the Dow every few days based on "good news" while the bad news either ignored or lead to a 0 day is totaly crazy ?
Real PCE is rising at a 1.3% annualized rate so far in Q2. The rate in Q1 was 4.2%. In Q4, it was 4.2%. Inventories and trade will probably add to Q2 GDP, after being a drag in Q1, but over the long haul, GDP tend to track final sales to domestics.
k harris,
What worries me is that business activity seems to be picking up (note the strong construction spending numbers today) without the foundation of the economy (consumer spending) keeping pace.
To me this implies a hard landing.
I suspect the disconnect comes from easy credit.
I see this in my home town where there is a frenzy of commercial and residential construction (although the latter is definitely slowing) despite the fact that the population here is shrinking outright.
If money is growing on trees, hell you might as well spend it.
Yal asked: "...is it just me who thinks that getting 90 points on the Dow every few days based on "good news" while the bad news either ignored or lead to a 0 day is totally crazy?"
I've been trying to make this point forever. Mixed economic news isn't enough to bring down either the economy or the stock market. Conditions have to be clearly, undeniably hostile, and they just aren't, haven't been for a long time.
Another number, closer to yours Tanta, from Bloomberg:
About $173 billion of CDOs backed mainly by U.S. subprime mortgage bonds and related derivatives were created last year, according to New York-based JPMorgan.
CDOs May Bring Subprime-Like Bust for LBOs, Junk Debt (Update3)
I don't know if they numbers ever will be completely hostile until we hit that systematic risk event that brings the whole thing crashing down. The numbers like today get spun into whatever the market thinks is good.
fjr said: "I don't know if they numbers ever will be completely hostile until we hit that systematic risk event that brings the whole thing crashing down."
Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed.
But, I've come to accept that no one here will ever believe me on this, so I'm at peace with that.
Tantissima--
So I was puzzling out why all the different numbers? And I looked at the Michael Hudson WSJ piece on Lehman from June 27 to understand the sources. He cites "Inside Mortgage Finance". So my question to you is: who dat?
I suspect there are a number of high yield hedge funds running their quarter-end mark-to-markets right now and finding that they're wiped out. When you're running with a gearing of 25:1, it only takes a 4% haircut on assets to wipe out your capital, and a lot of cdo's rated A and below that are being carried on the books at 90 should be marked down to more like 20, so they're well beyond the point of no return. Since there's no real secondary market for cdo's, and no way to put a real valuation on them, I think the street is going to agree on a mark of 75 to avoid a total catastrophe today, but a 15% haircut will still be enough to push any leveraged cdo junk fund over the ledge.
To put this in perspective, take a fund with $100 mio in capital, that levers up 25x (which is average, and there are some funds out there running 50x), and buys face value $2.777 bio worth of cdo's at 90 by borrowing $2.4 bio from its prime brokers (most likely GS, BS or Lehman, though all investment banks are in this game to some extent). At 75, the fund's holdings are now worth $2.082 bio, its capital is wiped out and its prime brokers are left with gaping holes in their balance sheets. In fact, they're actually left holding assets that can only be disposed of for $555 mio (if they can actually be sold at all) against their $2.4 bio in supposedly fully collateralized short-term margin loans. Obviously this is a worst case hedge fund example, but this may just be the neutron bomb that speeds up the slow motion train wreck we've all be observing for the past 18 months or so.
For me the direction we are heading is clear. I just don't know the time it would take to get there.
On the otherhand in some segments of the market we are already there - still stocks like DSL are behaving as if their situation only improved in the last year and stocks like KBH behave as if the worse is already behind them.
Q for Tanta: Whp are the paying clients of S&P, Moody's and Fitch?
Investors in bonds are the paying clients of the rating agencies. Those fees reduce your yield, children, in case you didn't know that. The fact that the bond underwriters are probably actually paying the invoices shouldn't confuse you. The bond underwriters manage to get reimbursed for that.
Who, Jas, would you prefer to have paying the rating agencies? The taxpayers?
There's a big issue, I think, about the rating agencies' fees being dependent on securitization dollar volume. (Just as there is a big issue about loan originators being paid on dollar volume). It creates a clear incentive to just get more deals done regardless of the quality of those deals.
But why shouldn't bondholders have to pay for ratings, Jas? Are you suggesting that there should be no investment costs for the rentier class? Or are you just setting yourself up for another jeremiad?
Can someone explain to me what is so great about the numbers today ?
Yal
The construction numbers are good, but those aren't leading indicators.
The important numbers - personal incomes and outlays - are poor and trending downwards. They bolster the case for a consumer-led recession; this is why the bond market rallied earlier.
The core PCE price index is cooling, which is positive unless it portends deflationary forces.
The stock market is not a rational market at this time, and does not respond rationally to economic data.
Sebastian - Your writing is a misconception. Wall Street and the "Markets" look forward 6 months or more. Trying to interpret what happens on any given day is a fools games - unknowable and unimportant.
The time to worry is when the "Market" stops going up on apparently good news.
There are a lot of good things happening in the global economy - real sychronized growth globally. This is a very powerful Bull Market - enjoy!
Sebastian wrote: Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed.
Forgive me, Sebastian, but I believe the opposite is true.
Systemic events result from leverage and not "catalysts". At some point the leverage is high enough such that any ol' thang can tip the system over. Of course afterwards the media makes a big deal about this or that worry-of-the-day the day it happens. Don't believe them.
LTCM came a surprise because the fund's leverage was, well, surprising.
The '87 crash happened because...heck, why did that happen, anyway?
The '29 crash. THAT was a doozy. We all remember what happened that fateful day to cause the crash! I mean, it was, it was...
Read "The Black Swan", Sebastian. Unsurprising events don't cause crashes because the market discounts them. By definition undiscounted events are a surprise, at least to "consensus".
He cites "Inside Mortgage Finance". So my question to you is: who dat?
IMF is an industry publication that has been around since Hector was a pup. It's subscription only and, I will say, vigilant about copyright infringement, so nobody sane posts IMF information without having permission to do so. They have a sister publication called "Inside B&C Finance," B&C being the old-fashioned term for "subprime" (as I said, this outfit has been around for a long time). They get their information from surveys and periodic reports from their industry subscribers. Most of us consider their data to be pretty good.
I agree with you fully. I thing that the signs are already there. But it won't be until something happens that something happens. (hows that for prophetic?)
Someone tell sebastian that losses are for loser's....
the Fed mandated that they are the winnner's....
thus, they made a rule...
No Credit Losses, ever, never
Fitch/S&P/Moody's do ratings based on historical losses and make a point to not forecast sector changes. Residential mortgage problems take a lot time to trickle through. From the time a borrower stops paying until it is decided to foreclose until the bank gets the property and auctions it can take over a year. Right now delinquency rates are up, but losses on the individual loans have not trickled through.
Tanta, Bloomberg TV had an interview with the author of this article but since structured finance is not my area of expertise I got lost when he started using terms like "overcollateralization" and "subordination".
Also, my state (MA) is considering some form of subprime bailout.
Well, putting the euro together with thie stock market, we have a bull session because inflation has been tamed and the Fed will ease: money will be printed.
Phantom stock shares lead to civil suit
By Wayne Jett
Pasadena Star-News
June 16, 2006
Two class action lawsuits filed by hedge funds in Manhattan federal court indicate major problems in U.S. stock markets. The hedge funds blame big brokerage firms for failing to deliver shares of stock "sold short" by the hedge funds. The problem: buyers who paid for shares didn't get the stock, but don't know it.
The hedge funds - Electronic Trading Group LLC and Quark Fund LLC - say they were swindled by their "prime brokers," including Merrill Lynch, Banc of America Securities, Goldman Sachs, Lehman Brothers, Citigroup, Bear Stearns and Morgan Stanley. ETG and Quark allege their prime brokers conspired to charge very high fees for securities lending services and to fail-to- deliver (FTD) shares required by law for "short sale" purposes. "Phantom" stock shares lead to civil suit
T said, "There's a big issue, I think, about the rating agencies' fees being dependent on securitization dollar volume. (Just as there is a big issue about loan originators being paid on dollar volume). It creates a clear incentive to just get more deals done regardless of the quality of those deals."
This is Jim Chanos' (Kynicos) thesis on why the ratings agencies are a good short in a nutshell . I suspect he is right and that he was the primary source for today's article in Bloomberg. He's been going crazy with the emails on the subject.
The principal source for the "alarmist" Bloomberg article is Joshua Rosner. I gave references for the reports he co-authored with Mason in my previous comment, here:
| HaloScan.com - Comments
The rating agency issue is the subject of the first reference that I gave its accompanying powerpoint presentation. The earlier report (my reference 4) discussed the fragility of CDO funding for mortgages.
Here are some figures from the earlier Mason & Rosner paper.
Just from eyeballing Fig. 12 on p. 25, "Annual Cash CDO Issuance," I deduce the following growth of total CDO issuance:
2004 $150 billion
2005 $250 billion
2006 $490 billion
Here are some quotes from pp. 26-27. I will not try to reproduce the tables, but these excerpts show how they analyzed the numbers for 2005 ONLY:
-- "The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006) Moodys CDO Asset Exposure Report for October 2006 reveals that 39.5 percent of the collateral within the 678 deals covered by Moodys consists of RMBS, just over 70 percent of that in subprime and home equity loans and the other 30 percent in prime first-lien loans. Hence, CDOs hold a lot of RMBS."
-- "Moodys CDO Asset Exposure Report for October 2006 reveals that 70 percent of collateral in the pools underlying the 2005 resecuritization CDO vintage was below AAA-rated, and the largest ratings cohort, at 40 percent, was Baa. About 10 percent of the 2005 vintage collateral pool was rated below Baa. Overall, about 75 percent of collateral in the pools underlying resecuritization CDOs was below AAA-rated, the largest cohort being, again, Baa at 42 percent. About 16 percent of collateral was rated below Baa."
... "Given the above observations, it is reasonable to infer that about 70 percent of the $200 billion, or about $140 billion, in MBS purchased by CDOs issued in 2005 is below AAA. As we demonstrated earlier, only some 10 percent or so of a typical MBS financing structure is made up of lower-tier (junior) securities. Those lower-tier (junior) tranches provide the desired credit support for the higher-tier (more senior) tranches. In other words, the entire MBS structure above the lower-tier (junior) tranches cannot be sold until those lower-tier (junior) tranches are sold.
-- "SIFMA estimates that about $1,326 billion was issued in private RMBS in 2005. If 10 percent of that is lower-tier (junior) securities, then about $133 billion in lower-tier securities supported the rest of the $1,193 billion."
-- Hence, the CDO market purchased more mezzanine MBS in 2005 as was actually issued that year. Furthermore, and crucially, the relatively small amount of MBS purchased by the CDO market provided support for the rest of the $1,193 billion issued in private RMBS during the entire year of 2005. The
"If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."
Benjamin Graham, Co-author of the 1934 classic, Security Analysis
Question: So investors shouldn't delude themselves about beating the market? Answer: "They're just not going to do it. It's just not going to happen."
Daniel Kahneman, Nobel Laureate in Economics, 2002
fjr said: "...But it won't be until something happens that something happens."
Just kicking it around here, but I don't think the "surprise" event is as important as the health of the economy and the stock market when the event occurs.
Also, whenever there is a "flight to quality" that means there is flight from something else. The behavior in that "something else" is what telegraphs the upcoming "surprise."
Sebastian, in an effort to be more "specific" let me lay out for you how a crash may occur without a "major catalyst":
CDO Hedge fund investors get their June statements:
"No losses! Yea! But wait, maaayyybbbee they're not telling me the truth. Shit I can redeem now and get all my money back, or I can wait and get..."
The faxes rain in with redemption forms (a "run" on the hedge funds). Word leaks out. No bids size bids in CDO-land, so it doesn't matter that the hedge funds have 45 days to liquidate: there's no volume to be had. Broker borrowing spreads rise, and they get margin calls and dump the very same securities their clients are trying to unload, which causes hedge funds to reprice downward. For a few weeks there the new-securitization market just shuts down. Credit availability plummets, and the feedback loop of lower expected home prices hits CDO's further. Rumors abound that Lehman or Bear will collapse, and news of hedge fund failures emerge daily. The market sells off 15% in one day.
Now, in that chain of events, what is the catalyst?
Ooops, here is the rest of my previous message which haloscan truncated:
-- Hence, the CDO market purchased more mezzanine MBS in 2005 as was actually issued that year. Furthermore, and crucially, the relatively small amount of MBS purchased by the CDO market provided support for the rest of the $1,193 billion issued in private RMBS during the entire year of 2005. The point, therefore, is that the CDO market adds liquidity to MBS and ABS markets in a highly leveraged fashion by funding lower-tranche MBS securities."
Mason & Rosner emphasize that CDO financing behaves like opportunistic "hot money" -- i.e., if the slicers'n'dicers have difficulty selling the poorer quality tranches, they will abandon the sector and look for other opportunities. The paper gives some past examples of this behavior.
The second report by Mason & Rosner concerns the relationship between the rating agencies and the issuers. I do not follow their statistical arguments, but I draw out the following interesting points:
o) The rating agencies may have forfeited their first amendment protection (i.e., could be sued) because of their involvement in the construction of CDOS. This mutual involvement was also criticised in the French report. It would be interesting to have a lawyer's point of view on this argument (which was developed on pp. 11-16 of their paper).
o) Because of inherent statistical incertainty, "ratings at inception are less meaningful for RMBS and CDOs than for corporate debt" (p. 43).
o) "Standard corporate bond rating techniques," when applied to poorly performing RMBS, lead to late and sudden downgrades (p. 44).
o) "The main problem we have described is that the RMBS market is built upon the shaky statistical predictability of mortgage pool performance. The CDO market then builds upon the shakier foundation of the statistical predictability of RMBS performance to provide additional market liquidity." It may take weeks or months for mortgage pool problems to affect the RMBS ratings and for the RMBS ratings to lead to CDO rating modifications (pp. 72-73).
I'm having trouble tracking the argument about the CDOs and Bloombergs numbers (I 'm not that smart)...but
I'd like to respond to Sabastian and YAL's point concerning why equities continue to rise on so-called good news and hold steady or fall little on bad news.
The answer relates to the question of the decade. Will Bernanke and company defend the economy (lower interest rates when demand and productivity falter), or defend the currency (raise interest rates) as investors and governments flee the dollar as our economy falters (and petro-dollars become a thing of the past).
The answer to the second question ( which leads to the answer to the first ) is that we have debased our currency and will continue to do so at an accelerated rate, as future commitments to retirees and others exceed the ability and / or the willingness of government and corporations to pay. Thus future commitments will be paid in dollars which buy less. That is how "they" get out from under the costs that have been pushed into the future. The Fed will not defend the currency.
Thus the stock indices stability at and rise above 13,000 on the Dow, for example, reflects a belief that the NAV of a given corporation, in the future, as the currency is devalued, will, in real terms, be much higher than the dollar value we see today.
However whether this scenario plays out this way with equity indices continuing upward, or unknowns come into play...once again, I'm not that smart, and that's scary because my families savings and my retirement are riding on the outcome...this is not a game.
"Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed."
I was agreeing with you up to this statement, Sebastian. The rare systemic risk events are almost always not telegraphed to the majority of people. An excellent and entertaining read on this common misperception is the book "Fooled by Randomness" by Nassim Taleb.
It doesn't offend me when communists argue against free markets. It really pisses me off when capitalists attempt to subvert them, though. And that is what we are seeing. -- MaxedOutMama, 28 June 2007
Yes, indeed. And now our friend Sebastian provides us with the very latest example of this phenomenon:
Take a 100% write-off of the entire $200 billion. That would be just under 1.5% of one year's nominal U.S. GDP.
Notice how he seeks to minimize the costs of private malfeasance by comparing them to the broadest measure of public wealth. This is the Greenspan/Bernanke legacy: the presumption that risks can be socialized at will. Don't count on it, folks.
Remedial homework for Sebastian: determine what percentage $200 billion is of the shareholders' equity of the broker/dealer index. (You may round your answer to the nearest hundred. ;>))
Take a 100% write-off of the entire $200 billion. That would be just under 1.5% of one year's nominal U.S. GDP. Or it would be about 100 days of SP500 company earnings.
You forgot to multiply on very conservative 5:1 leverage (Bear S. leverage was 10:1)
That would be just under 7.5% of one year's nominal U.S. GDP. Or it would be about 500 days of SP500 company earnings.
From the numbers that Tanta presents today it is very clear that not too many so called experts have much of an idea what is going on here.To me that is the scariest part of all of this.
No one has any clue how bad this Bond/Subprime/Housing problem will get. No one has any clue what losses any individual or company will face.
Consumers stand to lose the most in several ways:
Decreased value of their main asset their home.
Decrease in living standards by the possible loss of their home
Losses in stock invested in pension funds and 401k's caused by high risk investments.
Decreases in government programs such as Social Security and Medicare as pressure form deficit spending forces reductions in programs.
Higher local taxes and federal taxes for bail outs and for replacement of federal programs as federal spending decreases.
To me the best gauge of how bad it will get is to look at mortgage delinquency numbers. If they start trending down we might get out of this mess. If they keep climbing and we start to see an increase in the unemployment rates it is going to get uglier fast.
The other factor we need to consider is why are so many people interested in selling their homes all of a sudden. Are these sellers who are looking to cash out at or near the top of the market and may not need to sell or are they people who need to sell because of potential credit issues? The more distressed sellers we have the lower prices will go.
My guess based on delinquency numbers is that there are many distressed sellers in this group. If they can't sell they are foreclosures in waiting.
With the pool of potential buyers dwindling because of higher rates and tighter underwriting standards the outlook for home prices in the near term can't be good.
Decreased home prices means more losses for all the "Alphabet Bonds" in the market place.
My total estimate of the damage over this is between $1 and $3 TRILLION.
I am assuming:
15% of subprime mortgages issued from '05 to 1Q07 blow up.
5-6% of ALT-A from the same time period blows up.
Blowups from 04 and earlier do not exceed historical norms, and the stupidity stopped in 1Q 07.
The lower end of my estimate assumes modest uptake by margined players (hedge funds) with most in pensions and other non-margin leveraged accounts, plus a modest number of squareds and cubes in the mix.
The upper end assumes half or more are held by hedgies and squareds and cubes proliferated.
A cataclysmic failure occurs if this spills into the CLO and CMBX markets. If that happens then the losses will push a year's worth of GDP.
The ONLY good news is that about half of this PROBABLY nails people outside the US.
There is nothing good in here guys. The only thing we're arguing over here is whether the blast radius is 10 miles or 50 miles.
I am sure glad that there are folks who share my wonderment at the incline of the DOW. It just does not make sense. It would seem that bad news and stock gains are inversely related. Reminds me of a passage in a dotcom 2000 prospectus: The management may or may not remain with the company, there is no history of a working relationship between current management members and they do not have experience in industry". Company goes public and the stock moves up 200%, 23 months later staggering loss and the stock worthless! So, are we now seeing more of this blind faith?
BTW - I'm sticking to my number of $1.25T not $800M
The entire investment banking and hedge fund world are operating with an average leverage slightly over 25x, which is beyond the maximum leverage even LTCM thought they could safely operate at, and we all know how that ended. Given the unfolding drama in cdo's, and the nasty haircut some of these players are about to take, I would say there's a good chance we see some funky price action in financial markets that was neither telegraphed or has much to do with the underlying state of the economy.
It is no longer about contagion but rather amplification...
HEDGE HELL'S SPELL
U.K. FUND TO CLOSE
"June 29, 2007 -- The collapse of the subprime mortgage securities market continues to exact a heavy toll on hedge funds, with a London-based hedge fund closing its doors and a U.S. white-shoe private-equity shop taking a lower price for a mortgage fund share offering.
The $908 million Caliber Global Investment hedge fund announced it was shutting down after its management company, Cambridge Place Investment Management, concluded that losses in mortgage and structured product bonds could not be made up. The fund is set to wind down over the next 12 months.
Caliber's collapse is the second example within the week of the spreading woes from subprime mortgages, as Queens Walk Investment, a London-based publicly traded mortgage investment fund managed by Cheyne Capital, reported a $91 million annual loss.
According to statements by Cheyne's portfolio managers, Queens Walk had leverage levels of 28.5 times its capital, and with 12 percent of its capital in U.S. subprime mortgage bonds, suffered severe losses over the past two weeks.
Even Carlyle Group, the $59 billion, globe-spanning private-equity colossus, has felt the market's concerns over mortgage credit.
Barley said: "I am sure glad that there are folks who share my wonderment at the incline of the DOW. It just does not make sense. It would seem that bad news and stock gains are inversely related..."
As Tanta has pointed out, count on the news at your peril.
In the past 20 years, the "real" (after inflation) earnings yield on the SP500 has swung in a range from a low of negative 1/2 of 1% in March, 2000 to a high of +4.8% in July, 2002. (Just as a historical anecdote it was less than +1% at the top of the market in August, 1987 before the crash.)
Right now it's at +2.8%, right around its median value for the past two decades. No mysteries here as to why the stock market is behaving as it is.
Item 9 says it refers to GLOBAL numbers. Item 10 says it refers to US numbers. Its comparing apples and oranges
It shouldn't be comparing apples and oranges. It should be indicating that the value of CDOs sold to investors globally is larger than the value of CDOs sold just in the US, since we assume that the U.S. is only a part of the global market. So if the whole global market was $500 million, there's a problem with the U.S. portion of that being $375 billion.
(In fact, if you check the link, Bloomberg has updated the story and the global number is now $500 billion, not $500 million.)
You're right Sebastian, there is no mystery why the stock market is behaving as it is - it's called 10,000 hedge funds who employ trend following strategies and buy $25 worth of assets for every $1 of capital. The trend is your friend, until the day they're forced to liquidate to fund losses in other parts of their portfolios. I don't have the tautological belief in my own economic analysis that you appear to have. When I see a lot of big, ugly black storm clouds building over financial markets, which is most certainly the case today, I make sure I avoid getting soaked, rather than manifest my unshakable belief in sunshine tomorrow. Storms often build then dissapate into nothing, but somehow I don't think the next few weeks are going to be a good time for naked kite flying.
There seems to be a lot of confusion and misunderstandings on the recent headline news regarding the CDO "meltdown."
First, more seasoned subprime ABS from pre-2006 vintages have performed quite well. EPDs, delinquencies, and losses have behaved very well for these vintages, and so ABS CDOs referencing these underyling collateral are really not at risk (2yrs is the avg reset on ARMs, and prepay speeds typically flatten out at that 2yr mark).
Second, the very structure of CDOs are not standardized. Bespoke ABS CDOs can have varying degrees of tranche thickness, different credit enhancements and OC, wide-ranging degrees of coverage tests/triggers, and so forth. So you simply can't say all ABS CDOs are "trash." Each one is unique and has different attributes that make them either more or less risky than the next one. Some CDOs have mostly CLO collateral as the underlying (a cash CDO). Others have pools that reference CDS (syn CDOs) or even CDX/iTraxx Indexes. My point = not all CDOs are alike. 2 CDOs w/ the same exact reference obs can have different waterfalls, greater subordination to the SS tranches, and different levels of credit enhancements which all make the risk composition very different.
Third, ABS CDO investors don't care about defaults; they care about losses (LGD). Servicing provisions inherent in most subprime ABS allow for loan modification. News today on WaMu modifying $2 billion in subprime loans is a relief to those ABS investors. Both the servicer and the ABS investors benefits from the modified loan rather than declaring the loan in default, waiting a year for foreclosure to be complete, and several more months for the mortgage insurers to pay out on the CE. Another benefit to the mez, senior, and ss classes is that the losses don't hit the equity tranche which keeps the thickness of the support tranche intact.
Forth, ABS CDOs are for "Qualified Investors." Those investors that don't take the time or have the knowledge (the former is more realistic in this new era of "grab for yield") to stress test and perform scenario analysis on their CDO investments shouldn't be investing in these securities in the first place. I know for a fact, many HFs w/ exposure to subprime ABS CDOs properly hedged their risks using CDS, CDX Indexes, LCDS, LCDX, IG and HY tranche, and various other securities earlier this year. Those that didn't shouldn't be around - a sort of darwanian life-cycle is very necessary and worth the short-term pain.
Okay, you want to read something else that is equally frightening...and that is synergistic with the Bloomberg article:
Economists, however, caution that the picture of savings isn't as bad as it looks. The savings rate doesn't provide a complete picture of household finances because it doesn't capture gains from such things as real estate or financial investments.
How does one really not think this is a fatal two-car collision in slow motion?
when thinking of losses, it's always good to read from the money creator's
http://www.occ.treas.gov/ftp/deriv/dq406.pdf
pg 5
credit losses are small, if not ZERO
no one loses, wish upon a credit star.....
May -
Inflation 0.5%
Income growth - 0.4%
Few words about infaltion:
There are two-three kinds (or more):
For them inflation is low.
Real Consumer Spending and Income:
May Disposable Income (DPI): -0.1%
May Personal Consumption (PCE): 0.1%
May PCE Price Index: 0.5%
April DPI revised down to: -0.6%
March PCE revised down to: -0.1%
These numbers don't look too good to me.
May Personal Savings Rate: -1.4%
Is there any analysis discussing the impact of the mortgage crises on the TOTAL value of housing stock-a $20+ Trillion dollar asset clasee?
As homes go into foreclosure and inventory builds, it not only impacts that particular house, but all the houses in the area. As the process sprials, the impact is seemingly potentially enormous.
Any thoughts?
About those CDO numbers. As I recall the most reliable estimate, which also sounds like reasonable, is:
1. $800 b of subprime CDO
I don't know what you mean by a "subprime CDO."
There cannot be $800B in subprime paper held by CDOs if the entire market for subprime paper is $800B.
Remember all the uproar about Fannie and Freddie, for instance, buying subprime securities for their portfolio? Well, that'd be an example of subprime MBS outstanding that are not resecuritized into a CDO and held by a hedge fund.
The euro is behaving as though they just started printing money in the US.
Somebody doesn't like these numbers.
Not just the commenters on this blog.
Take a look at the trends for consumer spending and incomes:
Real Personal Income Month over Month Change
10/2006 0.7%
11/2006 0.3%
12/2006 0.2%
01/2007 0.6%
02/2007 0.3%
03/2007 0.3%
04/2007 -0.6%
05/2007 -0.1%
Real Personal Consumption Month over Month Change
10/2006 0.5%
11/2006 0.4%
12/2006 0.4%
01/2007 0.4%
02/2007 0.4%
03/2007 -0.1%
04/2007 0.2%
05/2007 0.1%
In the June 27 WSJ, the Mortgage Meltdown article allowed as how Wall St. sold $508 billion in "bonds" [sic] backed by subprime mortgages and in 2006 the market softened a bit--they still sold $483 billion. Can't quite make that jibe with Bloomberg, especially #9. Also in 2006, the top 5 underwriters packaged and sold $203.9 billion of subprime mortgage backed securities. (Again, WSJ article.) It strikes me that to get to $$483 billion, there must be a whole buch of underwriters...
AC,
Real PCE is rising at a 1.3% annualized rate so far in Q2. The rate in Q1 was 4.2%. In Q4, it was 4.2%. Inventories and trade will probably add to Q2 GDP, after being a drag in Q1, but over the long haul, GDP tend to track final sales to domestics.
David, the numbers I've seen thrown around most commonly for 2006 are:
~$650B in subprime mortgages originated
~$450-$520B of those were securitized
Let's call that an even $500B in subprime mortgage-backed securities issued in 2006.
If on average the total of the BBB- minus tranches offered for sale was 20%, which is a ridiculous number, that would mean $100B of yuck tranches available for resecuritization into CDOs.
But there's no earthly way that number is 20%. The Bloomberg article notes that Lehman's total 2006 SAIL bonds had a face value of $2.43B and BBB- tranches of $18MM.
So if $169B in low-rated subprime MBS tranches got resecuritized into CDOs just last year, they're either buying old tranches or they're buying higher-rated tranches or this $169B counts a lot of credit default swaps or double-counts some tranches (perhaps the CDO squareds are being added to the CDOs?)
Or, of course, the CDOs are into prime and Alt-A mortgages that are in trouble, but we're calling them all "subprime."
As usual, the more I read the more confused I get.
Tanta asked: "...Does anyone else want to take a stab at estimating the potential principal losses that exceed the current estimated principal losses on $200B in subprime ABS, so that we have some idea of how many dollars of losses the rating agencies are "hiding"?"
Sure, what the Hell.
Take a 100% write-off of the entire $200 billion. That would be just under 1.5% of one year's nominal U.S. GDP. Or it would be about 100 days of SP500 company earnings.
Sorry if you don't like the asterisks, Tanta, but I prefer not to shout in all-caps.
Sebastian
Can someone explain to me what is so great about the numbers today ?
Consumption up (but not by much) , income below expectations, infaltion in check (1.9 Vs 2.0 - which is Fed maximum comfort level).
But wait: we get a new measure on infaltion every day. yesterday inflation numbers were not so good.
on the other hand AHM losses, 9.75% loan. KBH is now higher than it was before the "unexpected" losses. CFC up after the down grade. (and btw, after all the 6 month of rumors CFC did not went down after BoA said: not intersted in buying CFC)
is it just me who thinks that getting 90 points on the Dow every few days based on "good news" while the bad news either ignored or lead to a 0 day is totaly crazy ?
will this go on for ever ? (of course not)
--
Q for Tanta: Whp are the paying clients of S&P, Moody's and Fitch?
TIA,
Jas
And... the market rockets upwards.
shrug
Cheers,
prat
Real PCE is rising at a 1.3% annualized rate so far in Q2. The rate in Q1 was 4.2%. In Q4, it was 4.2%. Inventories and trade will probably add to Q2 GDP, after being a drag in Q1, but over the long haul, GDP tend to track final sales to domestics.
k harris,
What worries me is that business activity seems to be picking up (note the strong construction spending numbers today) without the foundation of the economy (consumer spending) keeping pace.
To me this implies a hard landing.
I suspect the disconnect comes from easy credit.
I see this in my home town where there is a frenzy of commercial and residential construction (although the latter is definitely slowing) despite the fact that the population here is shrinking outright.
If money is growing on trees, hell you might as well spend it.
Yal asked: "...is it just me who thinks that getting 90 points on the Dow every few days based on "good news" while the bad news either ignored or lead to a 0 day is totally crazy?"
I've been trying to make this point forever.
Mixed economic news isn't enough to bring down either the economy or the stock market. Conditions have to be clearly, undeniably hostile, and they just aren't, haven't been for a long time.
Sebastia
Another number, closer to yours Tanta, from Bloomberg:
About $173 billion of CDOs backed mainly by U.S. subprime mortgage bonds and related derivatives were created last year, according to New York-based JPMorgan.
CDOs May Bring Subprime-Like Bust for LBOs, Junk Debt (Update3)
By Caroline Salas and Darrell Hassler
March 13
Woops, link:
CDOs May Bring Subprime-Like Bust for LBOs, Junk Debt (Update3) - Bloomberg.com
I don't know if they numbers ever will be completely hostile until we hit that systematic risk event that brings the whole thing crashing down. The numbers like today get spun into whatever the market thinks is good.
fjr said: "I don't know if they numbers ever will be completely hostile until we hit that systematic risk event that brings the whole thing crashing down."
Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed.
But, I've come to accept that no one here will ever believe me on this, so I'm at peace with that.
Sebastia
Tantissima--
So I was puzzling out why all the different numbers? And I looked at the Michael Hudson WSJ piece on Lehman from June 27 to understand the sources. He cites "Inside Mortgage Finance". So my question to you is: who dat?
I suspect there are a number of high yield hedge funds running their quarter-end mark-to-markets right now and finding that they're wiped out. When you're running with a gearing of 25:1, it only takes a 4% haircut on assets to wipe out your capital, and a lot of cdo's rated A and below that are being carried on the books at 90 should be marked down to more like 20, so they're well beyond the point of no return. Since there's no real secondary market for cdo's, and no way to put a real valuation on them, I think the street is going to agree on a mark of 75 to avoid a total catastrophe today, but a 15% haircut will still be enough to push any leveraged cdo junk fund over the ledge.
To put this in perspective, take a fund with $100 mio in capital, that levers up 25x (which is average, and there are some funds out there running 50x), and buys face value $2.777 bio worth of cdo's at 90 by borrowing $2.4 bio from its prime brokers (most likely GS, BS or Lehman, though all investment banks are in this game to some extent). At 75, the fund's holdings are now worth $2.082 bio, its capital is wiped out and its prime brokers are left with gaping holes in their balance sheets. In fact, they're actually left holding assets that can only be disposed of for $555 mio (if they can actually be sold at all) against their $2.4 bio in supposedly fully collateralized short-term margin loans. Obviously this is a worst case hedge fund example, but this may just be the neutron bomb that speeds up the slow motion train wreck we've all be observing for the past 18 months or so.
Sebs,
I know that but thanks.
For me the direction we are heading is clear. I just don't know the time it would take to get there.
On the otherhand in some segments of the market we are already there - still stocks like DSL are behaving as if their situation only improved in the last year and stocks like KBH behave as if the worse is already behind them.
Q for Tanta: Whp are the paying clients of S&P, Moody's and Fitch?
Investors in bonds are the paying clients of the rating agencies. Those fees reduce your yield, children, in case you didn't know that. The fact that the bond underwriters are probably actually paying the invoices shouldn't confuse you. The bond underwriters manage to get reimbursed for that.
Who, Jas, would you prefer to have paying the rating agencies? The taxpayers?
There's a big issue, I think, about the rating agencies' fees being dependent on securitization dollar volume. (Just as there is a big issue about loan originators being paid on dollar volume). It creates a clear incentive to just get more deals done regardless of the quality of those deals.
But why shouldn't bondholders have to pay for ratings, Jas? Are you suggesting that there should be no investment costs for the rentier class? Or are you just setting yourself up for another jeremiad?
Can someone explain to me what is so great about the numbers today ?
Yal
The construction numbers are good, but those aren't leading indicators.
The important numbers - personal incomes and outlays - are poor and trending downwards. They bolster the case for a consumer-led recession; this is why the bond market rallied earlier.
The core PCE price index is cooling, which is positive unless it portends deflationary forces.
The stock market is not a rational market at this time, and does not respond rationally to economic data.
Sebastian - Your writing is a misconception. Wall Street and the "Markets" look forward 6 months or more. Trying to interpret what happens on any given day is a fools games - unknowable and unimportant.
The time to worry is when the "Market" stops going up on apparently good news.
There are a lot of good things happening in the global economy - real sychronized growth globally. This is a very powerful Bull Market - enjoy!
Sebastian wrote: Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed.
Forgive me, Sebastian, but I believe the opposite is true.
Systemic events result from leverage and not "catalysts". At some point the leverage is high enough such that any ol' thang can tip the system over. Of course afterwards the media makes a big deal about this or that worry-of-the-day the day it happens. Don't believe them.
LTCM came a surprise because the fund's leverage was, well, surprising.
The '87 crash happened because...heck, why did that happen, anyway?
The '29 crash. THAT was a doozy. We all remember what happened that fateful day to cause the crash! I mean, it was, it was...
Read "The Black Swan", Sebastian. Unsurprising events don't cause crashes because the market discounts them. By definition undiscounted events are a surprise, at least to "consensus".
Good thing we're not part of "consensus".
He cites "Inside Mortgage Finance". So my question to you is: who dat?
IMF is an industry publication that has been around since Hector was a pup. It's subscription only and, I will say, vigilant about copyright infringement, so nobody sane posts IMF information without having permission to do so. They have a sister publication called "Inside B&C Finance," B&C being the old-fashioned term for "subprime" (as I said, this outfit has been around for a long time). They get their information from surveys and periodic reports from their industry subscribers. Most of us consider their data to be pretty good.
Seb,
I agree with you fully. I thing that the signs are already there. But it won't be until something happens that something happens. (hows that for prophetic?)
Until then, it is up and up unfortunately.
Someone tell sebastian that losses are for loser's....
the Fed mandated that they are the winnner's....
thus, they made a rule...
No Credit Losses, ever, never
see for yourself..
pg 5
http://www.occ.treas.gov/ftp/deriv/dq406.pdf
Let's not forget about the end-of-quarter window-dressing proclivities of our buy-side brethren...
Fitch/S&P/Moody's do ratings based on historical losses and make a point to not forecast sector changes. Residential mortgage problems take a lot time to trickle through. From the time a borrower stops paying until it is decided to foreclose until the bank gets the property and auctions it can take over a year. Right now delinquency rates are up, but losses on the individual loans have not trickled through.
Wow, our "visitor online" counter is over the century mark. Welcome all.
Tanta, Bloomberg TV had an interview with the author of this article but since structured finance is not my area of expertise I got lost when he started using terms like "overcollateralization" and "subordination".
Also, my state (MA) is considering some form of subprime bailout.
Well, putting the euro together with thie stock market, we have a bull session because inflation has been tamed and the Fed will ease: money will be printed.
That's the bull case.
Phantom stock shares lead to civil suit
By Wayne Jett
Pasadena Star-News
June 16, 2006
Two class action lawsuits filed by hedge funds in Manhattan federal court indicate major problems in U.S. stock markets. The hedge funds blame big brokerage firms for failing to deliver shares of stock "sold short" by the hedge funds. The problem: buyers who paid for shares didn't get the stock, but don't know it.
The hedge funds - Electronic Trading Group LLC and Quark Fund LLC - say they were swindled by their "prime brokers," including Merrill Lynch, Banc of America Securities, Goldman Sachs, Lehman Brothers, Citigroup, Bear Stearns and Morgan Stanley. ETG and Quark allege their prime brokers conspired to charge very high fees for securities lending services and to fail-to- deliver (FTD) shares required by law for "short sale" purposes.
"Phantom" stock shares lead to civil suit
We have a case of the "phantom" cdo's
T said, "There's a big issue, I think, about the rating agencies' fees being dependent on securitization dollar volume. (Just as there is a big issue about loan originators being paid on dollar volume). It creates a clear incentive to just get more deals done regardless of the quality of those deals."
This is Jim Chanos' (Kynicos) thesis on why the ratings agencies are a good short in a nutshell . I suspect he is right and that he was the primary source for today's article in Bloomberg. He's been going crazy with the emails on the subject.
The principal source for the "alarmist" Bloomberg article is Joshua Rosner. I gave references for the reports he co-authored with Mason in my previous comment, here:
| HaloScan.com - Comments
The rating agency issue is the subject of the first reference that I gave its accompanying powerpoint presentation. The earlier report (my reference 4) discussed the fragility of CDO funding for mortgages.
Here are some figures from the earlier Mason & Rosner paper.
Just from eyeballing Fig. 12 on p. 25, "Annual Cash CDO Issuance," I deduce the following growth of total CDO issuance:
2004 $150 billion
2005 $250 billion
2006 $490 billion
Here are some quotes from pp. 26-27. I will not try to reproduce the tables, but these excerpts show how they analyzed the numbers for 2005 ONLY:
-- "The FDIC reports that 81 percent of the $249 billion of CDO collateral pools issued in 2005, or $200 billion, was made up of residential mortgage products. (FDIC Outlook, Fall 2006) Moodys CDO Asset Exposure Report for October 2006 reveals that 39.5 percent of the collateral within the 678 deals covered by Moodys consists of RMBS, just over 70 percent of that in subprime and home equity loans and the other 30 percent in prime first-lien loans. Hence, CDOs hold a lot of RMBS."
-- "Moodys CDO Asset Exposure Report for October 2006 reveals that 70 percent of collateral in the pools underlying the 2005 resecuritization CDO vintage was below AAA-rated, and the largest ratings cohort, at 40 percent, was Baa. About 10 percent of the 2005 vintage collateral pool was rated below Baa. Overall, about 75 percent of collateral in the pools underlying resecuritization CDOs was below AAA-rated, the largest cohort being, again, Baa at 42 percent. About 16 percent of collateral was rated below Baa."
... "Given the above observations, it is reasonable to infer that about 70 percent of the $200 billion, or about $140 billion, in MBS purchased by CDOs issued in 2005 is below AAA. As we demonstrated earlier, only some 10 percent or so of a typical MBS financing structure is made up of lower-tier (junior) securities. Those lower-tier (junior) tranches provide the desired credit support for the higher-tier (more senior) tranches. In other words, the entire MBS structure above the lower-tier (junior) tranches cannot be sold until those lower-tier (junior) tranches are sold.
-- "SIFMA estimates that about $1,326 billion was issued in private RMBS in 2005. If 10 percent of that is lower-tier (junior) securities, then about $133 billion in lower-tier securities supported the rest of the $1,193 billion."
-- Hence, the CDO market purchased more mezzanine MBS in 2005 as was actually issued that year. Furthermore, and crucially, the relatively small amount of MBS purchased by the CDO market provided support for the rest of the $1,193 billion issued in private RMBS during the entire year of 2005. The
Major events are telegraphed?
"If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what's going to happen to the stock market."
Benjamin Graham, Co-author of the 1934 classic, Security Analysis
Question: So investors shouldn't delude themselves about beating the market? Answer: "They're just not going to do it. It's just not going to happen."
Daniel Kahneman, Nobel Laureate in Economics, 2002
fjr said: "...But it won't be until something happens that something happens."
Just kicking it around here, but I don't think the "surprise" event is as important as the health of the economy and the stock market when the event occurs.
Also, whenever there is a "flight to quality" that means there is flight from something else. The behavior in that "something else" is what telegraphs the upcoming "surprise."
JMO and FWIW.
Sebastia
Sebastian, in an effort to be more "specific" let me lay out for you how a crash may occur without a "major catalyst":
CDO Hedge fund investors get their June statements:
"No losses! Yea! But wait, maaayyybbbee they're not telling me the truth. Shit I can redeem now and get all my money back, or I can wait and get..."
The faxes rain in with redemption forms (a "run" on the hedge funds). Word leaks out. No bids size bids in CDO-land, so it doesn't matter that the hedge funds have 45 days to liquidate: there's no volume to be had. Broker borrowing spreads rise, and they get margin calls and dump the very same securities their clients are trying to unload, which causes hedge funds to reprice downward. For a few weeks there the new-securitization market just shuts down. Credit availability plummets, and the feedback loop of lower expected home prices hits CDO's further. Rumors abound that Lehman or Bear will collapse, and news of hedge fund failures emerge daily. The market sells off 15% in one day.
Now, in that chain of events, what is the catalyst?
Ooops, here is the rest of my previous message which haloscan truncated:
-- Hence, the CDO market purchased more mezzanine MBS in 2005 as was actually issued that year. Furthermore, and crucially, the relatively small amount of MBS purchased by the CDO market provided support for the rest of the $1,193 billion issued in private RMBS during the entire year of 2005. The point, therefore, is that the CDO market adds liquidity to MBS and ABS markets in a highly leveraged fashion by funding lower-tranche MBS securities."
Mason & Rosner emphasize that CDO financing behaves like opportunistic "hot money" -- i.e., if the slicers'n'dicers have difficulty selling the poorer quality tranches, they will abandon the sector and look for other opportunities. The paper gives some past examples of this behavior.
Ala
The second report by Mason & Rosner concerns the relationship between the rating agencies and the issuers. I do not follow their statistical arguments, but I draw out the following interesting points:
o) The rating agencies may have forfeited their first amendment protection (i.e., could be sued) because of their involvement in the construction of CDOS. This mutual involvement was also criticised in the French report. It would be interesting to have a lawyer's point of view on this argument (which was developed on pp. 11-16 of their paper).
o) Because of inherent statistical incertainty, "ratings at inception are less meaningful for RMBS and CDOs than for corporate debt" (p. 43).
o) "Standard corporate bond rating techniques," when applied to poorly performing RMBS, lead to late and sudden downgrades (p. 44).
o) "The main problem we have described is that the RMBS market is built upon the shaky statistical predictability of mortgage pool performance. The CDO market then builds upon the shakier foundation of the statistical predictability of RMBS performance to provide additional market liquidity." It may take weeks or months for mortgage pool problems to affect the RMBS ratings and for the RMBS ratings to lead to CDO rating modifications (pp. 72-73).
Ala
I'm having trouble tracking the argument about the CDOs and Bloombergs numbers (I 'm not that smart)...but
I'd like to respond to Sabastian and YAL's point concerning why equities continue to rise on so-called good news and hold steady or fall little on bad news.
The answer relates to the question of the decade. Will Bernanke and company defend the economy (lower interest rates when demand and productivity falter), or defend the currency (raise interest rates) as investors and governments flee the dollar as our economy falters (and petro-dollars become a thing of the past).
The answer to the second question ( which leads to the answer to the first ) is that we have debased our currency and will continue to do so at an accelerated rate, as future commitments to retirees and others exceed the ability and / or the willingness of government and corporations to pay. Thus future commitments will be paid in dollars which buy less. That is how "they" get out from under the costs that have been pushed into the future. The Fed will not defend the currency.
Thus the stock indices stability at and rise above 13,000 on the Dow, for example, reflects a belief that the NAV of a given corporation, in the future, as the currency is devalued, will, in real terms, be much higher than the dollar value we see today.
However whether this scenario plays out this way with equity indices continuing upward, or unknowns come into play...once again, I'm not that smart, and that's scary because my families savings and my retirement are riding on the outcome...this is not a game.
"Systematic risk events that are big enough to matter don't appear out of nowhere, they're always telegraphed."
I was agreeing with you up to this statement, Sebastian. The rare systemic risk events are almost always not telegraphed to the majority of people. An excellent and entertaining read on this common misperception is the book "Fooled by Randomness" by Nassim Taleb.
Tanta,
Or, of course, the CDOs are into prime and Alt-A mortgages that are in trouble, but we're calling them all "subprime.">/i>
Wait a minute... we are??
It doesn't offend me when communists argue against free markets. It really pisses me off when capitalists attempt to subvert them, though. And that is what we are seeing. -- MaxedOutMama, 28 June 2007
Yes, indeed. And now our friend Sebastian provides us with the very latest example of this phenomenon:
Take a 100% write-off of the entire $200 billion. That would be just under 1.5% of one year's nominal U.S. GDP.
Notice how he seeks to minimize the costs of private malfeasance by comparing them to the broadest measure of public wealth. This is the Greenspan/Bernanke legacy: the presumption that risks can be socialized at will. Don't count on it, folks.
Remedial homework for Sebastian: determine what percentage $200 billion is of the shareholders' equity of the broker/dealer index. (You may round your answer to the nearest hundred. ;>))
You forgot to multiply on very conservative 5:1 leverage (Bear S. leverage was 10:1)
That would be just under 7.5% of one year's nominal U.S. GDP. Or it would be about 500 days of SP500 company earnings.
From the numbers that Tanta presents today it is very clear that not too many so called experts have much of an idea what is going on here.To me that is the scariest part of all of this.
No one has any clue how bad this Bond/Subprime/Housing problem will get. No one has any clue what losses any individual or company will face.
Consumers stand to lose the most in several ways:
To me the best gauge of how bad it will get is to look at mortgage delinquency numbers. If they start trending down we might get out of this mess. If they keep climbing and we start to see an increase in the unemployment rates it is going to get uglier fast.
The other factor we need to consider is why are so many people interested in selling their homes all of a sudden. Are these sellers who are looking to cash out at or near the top of the market and may not need to sell or are they people who need to sell because of potential credit issues? The more distressed sellers we have the lower prices will go.
My guess based on delinquency numbers is that there are many distressed sellers in this group. If they can't sell they are foreclosures in waiting.
With the pool of potential buyers dwindling because of higher rates and tighter underwriting standards the outlook for home prices in the near term can't be good.
Decreased home prices means more losses for all the "Alphabet Bonds" in the market place.
More collateral damage-
Bear Stearns head of asset management gone.
My total estimate of the damage over this is between $1 and $3 TRILLION.
I am assuming:
15% of subprime mortgages issued from '05 to 1Q07 blow up.
5-6% of ALT-A from the same time period blows up.
Blowups from 04 and earlier do not exceed historical norms, and the stupidity stopped in 1Q 07.
The lower end of my estimate assumes modest uptake by margined players (hedge funds) with most in pensions and other non-margin leveraged accounts, plus a modest number of squareds and cubes in the mix.
The upper end assumes half or more are held by hedgies and squareds and cubes proliferated.
A cataclysmic failure occurs if this spills into the CLO and CMBX markets. If that happens then the losses will push a year's worth of GDP.
The ONLY good news is that about half of this PROBABLY nails people outside the US.
There is nothing good in here guys. The only thing we're arguing over here is whether the blast radius is 10 miles or 50 miles.
Tanta;
Item 9 says it refers to GLOBAL numbers. Item 10 says it refers to US numbers. Its comparing apples and oranges
I am sure glad that there are folks who share my wonderment at the incline of the DOW. It just does not make sense. It would seem that bad news and stock gains are inversely related. Reminds me of a passage in a dotcom 2000 prospectus: The management may or may not remain with the company, there is no history of a working relationship between current management members and they do not have experience in industry". Company goes public and the stock moves up 200%, 23 months later staggering loss and the stock worthless! So, are we now seeing more of this blind faith?
BTW - I'm sticking to my number of $1.25T not $800M
The entire investment banking and hedge fund world are operating with an average leverage slightly over 25x, which is beyond the maximum leverage even LTCM thought they could safely operate at, and we all know how that ended. Given the unfolding drama in cdo's, and the nasty haircut some of these players are about to take, I would say there's a good chance we see some funky price action in financial markets that was neither telegraphed or has much to do with the underlying state of the economy.
Right about the foreign aspect.
It is no longer about contagion but rather amplification...
HEDGE HELL'S SPELL
U.K. FUND TO CLOSE
"June 29, 2007 -- The collapse of the subprime mortgage securities market continues to exact a heavy toll on hedge funds, with a London-based hedge fund closing its doors and a U.S. white-shoe private-equity shop taking a lower price for a mortgage fund share offering.
The $908 million Caliber Global Investment hedge fund announced it was shutting down after its management company, Cambridge Place Investment Management, concluded that losses in mortgage and structured product bonds could not be made up. The fund is set to wind down over the next 12 months.
Caliber's collapse is the second example within the week of the spreading woes from subprime mortgages, as Queens Walk Investment, a London-based publicly traded mortgage investment fund managed by Cheyne Capital, reported a $91 million annual loss.
According to statements by Cheyne's portfolio managers, Queens Walk had leverage levels of 28.5 times its capital, and with 12 percent of its capital in U.S. subprime mortgage bonds, suffered severe losses over the past two weeks.
Even Carlyle Group, the $59 billion, globe-spanning private-equity colossus, has felt the market's concerns over mortgage credit.
Barley said: "I am sure glad that there are folks who share my wonderment at the incline of the DOW. It just does not make sense. It would seem that bad news and stock gains are inversely related..."
As Tanta has pointed out, count on the news at your peril.
In the past 20 years, the "real" (after inflation) earnings yield on the SP500 has swung in a range from a low of negative 1/2 of 1% in March, 2000 to a high of +4.8% in July, 2002. (Just as a historical anecdote it was less than +1% at the top of the market in August, 1987 before the crash.)
Right now it's at +2.8%, right around its median value for the past two decades. No mysteries here as to why the stock market is behaving as it is.
Sebastia
Item 9 says it refers to GLOBAL numbers. Item 10 says it refers to US numbers. Its comparing apples and oranges
It shouldn't be comparing apples and oranges. It should be indicating that the value of CDOs sold to investors globally is larger than the value of CDOs sold just in the US, since we assume that the U.S. is only a part of the global market. So if the whole global market was $500 million, there's a problem with the U.S. portion of that being $375 billion.
(In fact, if you check the link, Bloomberg has updated the story and the global number is now $500 billion, not $500 million.)
You're right Sebastian, there is no mystery why the stock market is behaving as it is - it's called 10,000 hedge funds who employ trend following strategies and buy $25 worth of assets for every $1 of capital. The trend is your friend, until the day they're forced to liquidate to fund losses in other parts of their portfolios. I don't have the tautological belief in my own economic analysis that you appear to have. When I see a lot of big, ugly black storm clouds building over financial markets, which is most certainly the case today, I make sure I avoid getting soaked, rather than manifest my unshakable belief in sunshine tomorrow. Storms often build then dissapate into nothing, but somehow I don't think the next few weeks are going to be a good time for naked kite flying.
News organizations like Bloomberg do not stake out a position just for the hell of it, and that's what they did with this article.
I should have added that Bloomberg intends to own this story, and that's why they are taking a position.
"The '87 crash happened because...heck, why did that happen, anyway?"
Because tons of fund managers were all holding the same type of portfolio insurance.
But you are correct. Crises are never telegraphed.
There seems to be a lot of confusion and misunderstandings on the recent headline news regarding the CDO "meltdown."
First, more seasoned subprime ABS from pre-2006 vintages have performed quite well. EPDs, delinquencies, and losses have behaved very well for these vintages, and so ABS CDOs referencing these underyling collateral are really not at risk (2yrs is the avg reset on ARMs, and prepay speeds typically flatten out at that 2yr mark).
Second, the very structure of CDOs are not standardized. Bespoke ABS CDOs can have varying degrees of tranche thickness, different credit enhancements and OC, wide-ranging degrees of coverage tests/triggers, and so forth. So you simply can't say all ABS CDOs are "trash." Each one is unique and has different attributes that make them either more or less risky than the next one. Some CDOs have mostly CLO collateral as the underlying (a cash CDO). Others have pools that reference CDS (syn CDOs) or even CDX/iTraxx Indexes. My point = not all CDOs are alike. 2 CDOs w/ the same exact reference obs can have different waterfalls, greater subordination to the SS tranches, and different levels of credit enhancements which all make the risk composition very different.
Third, ABS CDO investors don't care about defaults; they care about losses (LGD). Servicing provisions inherent in most subprime ABS allow for loan modification. News today on WaMu modifying $2 billion in subprime loans is a relief to those ABS investors. Both the servicer and the ABS investors benefits from the modified loan rather than declaring the loan in default, waiting a year for foreclosure to be complete, and several more months for the mortgage insurers to pay out on the CE. Another benefit to the mez, senior, and ss classes is that the losses don't hit the equity tranche which keeps the thickness of the support tranche intact.
Forth, ABS CDOs are for "Qualified Investors." Those investors that don't take the time or have the knowledge (the former is more realistic in this new era of "grab for yield") to stress test and perform scenario analysis on their CDO investments shouldn't be investing in these securities in the first place. I know for a fact, many HFs w/ exposure to subprime ABS CDOs properly hedged their risks using CDS, CDX Indexes, LCDS, LCDX, IG and HY tranche, and various other securities earlier this year. Those that didn't shouldn't be around - a sort of darwanian life-cycle is very necessary and worth the short-term pain.
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