Nouriel Roubini might have been your only comrade in arms as far as sounding the alarm early on alt-A.
As to your questions about illiquidity: I remember the old junk bond days. At the worst of it (1990) it would be hard to get any bids at all for lesser-known pieces. Information was usually there though because most issuers reported to the SEC.
Contrast this to the current MBS markets. I don't doubt you can get all the prospectuses and documentation you want on plain vanilla GSE paper. But as you say -- if info is that hard to come by on individual securities, bids will be too. Another comparison: you would expect security analysts to cover junk bond companies -- and bond analysts to cover GSE paper -- but who would have published opinions on these little private MBS deals? My guess? Fuggedaboutit!
Since such instruments typically last three to five years and the CDO boom is so recent many have not come to the end of their life.
Don't ask me what "typically" might mean when it is followed by "the CDO boom is so recent." I certainly hope it doesn't mean "our CPR models told us this stuff would pay off so fast that we'd never be stuck with a duration problem." Or, perhaps, "we assumed we could force the MBS issuer to call the underlying security even when the issuer is not obligated to and it is not "economic" for the issuer to do that."
Great post. Fantastic. Loved your point that illiquidity/low transparency is a feature, not a bug. It was designed to be this way.
Let's face it: hedge funds and other participants are trying to make money on the parts of the market that are harder to figure out, because they're (allegedly) "smarter." As risk premiums came down, the Street found a way to create product for those demanding it: complicated, illiquid and untransparent.
This paper was created precisely for those who wanted to skate on the edge, precisely at the time when everyone collectively decided they wanted to skate on the edge too, by those who make money sharpening the skates. And now it's the pond's fault.
Tanta, another excellent post. I would describe this not as "the worm turning", but as "intelligence returning".
It seems odd to write this now, but very recently the markets knew how to write loans relatively cheaply and relatively safely, and I think we can all dig deep and remember how. If not, we have you to remind us!
we've innovated our way into a situation in which nobody has the first bloody idea what's going on with the securities they're in or the CDOs that buy the tranches of the securities or the hedge funds that buy the tranches of the CDOs of the securities of the mortgages that were written on a hope and a prayer and a FICO.
Any time an investment is opaque it's really a violation of free market rules. I think we have to look at what has worked in the past - reasonable regulation - and then figure out how to apply reasonable regulation in the present. What angers me the most is that those who should be arguing for that regulation (I am talking Paulson and that lovely hedge fund "guidance" of a few months ago) are the people trying to further muddy the waters.
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.
This paper was created precisely for those who wanted to skate on the edge, precisely at the time when everyone collectively decided they wanted to skate on the edge too, by those who make money sharpening the skates. And now it's the pond's fault.
How about this: the paper was created for those who want to feed on the bottom. So after everyone jumped into this Big Muddy River and thrashed around for a while, they're now complaining that the water's too murky to see through.
Or maybe it's just a bunch of kiddies who peed in the swimming pool. These analogies become dangerous . . .
Tanta. Your articles are good, but I think much too long for some of us. As a result, I stopped reading them. Please consider editing them to a much shorter length.
Is there any sort of chart of when these CDOs start to "come to the end of their life" ? It would seem that it is going to be very interesting when these things start to become 'unmade'. Maybe they won't be the only things getting 'unmade'.
SteveB doesn't speak for most of us. Your articles are great. If we wanted newsclips we would just read the headlines off of Bloomberg. I heart the detail and your excellent writing.
I understood the problem with these mortgages over 2 1/2 years ago, because of people like Bill Bonner at Lew Rockwell.com. The problem is the MSM feeds the public a diet of spin and misinformation that is so dense the public can't hack through it to find the truth. We have to face the fact that Paris Hilton gets more coverage on TV than foreclosures, the real estate downturn, or CDOs. The vast majority of the peole I know still think that real estate only goes up, and don't get me started on my inlaws.
steveb, you're fighting a losing battle. Just about every time I do a long post I get at least one person complaining that it was too long, followed by at least one and usually several loyal CR readers piling onto that comment to the effect that people come here for long, detailed stuff.
Besides the fact that there are many, many places on the net you can get the short version, but only a few where you get the drill-down, I want to point out that the whole gist of the post is that shorthand arguments--"the hedge fund meltdown is about bad subprime paper"--are hard to kill precisely because it takes more than a few sentences to explain what the problem is, and in our attention-span-deprived world most journalists won't devote more than a few sentences to anything.
Please stay with the longer postings. I often skip them, because I don't have time to read them. But when I do have time, they are worthwhile and I learn some things. Plus, they make good reference material...
"Tanta. Your articles are good, but I think much too long for some of us. As a result, I stopped reading them. Please consider editing them to a much shorter length."
Disagree. Too short. I like a Tanta blog entry that takes approximately my lunch hour to absorb. Tanta's entries get me through my first pre-lunch smoke.
One of your best articles ever, Tanta, saying oh so many things that really need to be said.
I believe the opacity is very much by design, and that these securities are a direct analog to Enron's opaque "Special-Purpose Entities". The hedgies need securities which they can "mark to model" (again like Enron) so as to support claims of huge short-term profits from which to take their 20% cut, while maintaining plausible deniability to avoid imprisonment and clawback of the profits by the marks' lawyers in the long term. Opacity serves both ends.
That deregulation has resulted in a situation in which none of the bank regulatory agencies can evaluate the securities is both horrifying and hilarious. The end result, of course, will be awesome financial carnage and reimposition of the kind of regulations that used to prevent this.
It is wonderful that you remind everyone that for decades we managed to have a smoothly functioning mortgage financing system without any of this Absolute Bull S**t.
You're so right -- an illiquid market is one in which you don't like the bid!
I think the thing to keep in mind is that CDO's have manufactured demand for the underlying paper. When I say manufactured, I mean that because of leverage, a hedge fund or pension fund was buying more paper in a CDO than they would have bought directly. This accounts for the originators' attitude towards 'snow doc' lending: it wasn't that they were so stupid, its just that its what they HAD TO DO to keep up with demand for securitizations.
The point is that slowing demand for CDO's means new demand for mortgage securitizations should fall quicker than you can say "illiquid". That's the important thing: no CDO's, no demand for 'snow docs', tighter standards. Not because the originators are all of a sudden smart, but because that's what they HAVE TO DO to keep up with falling demand.
A) I actually read Tanta first, so up the votes for length.
B) More drink recipes please: I simply can't cope with the state of the economy and the actions of the Bush admin and judiciary in the same space-time locus, not without help.
Tanta, I echo the encouragement to stay with the long posts. The MSM is the one that has to stick with sound bites so that a dumbed-down public with a short attention span won't change the channel.
This is not an MSM audience. I especially hearing at length from someone who obviously knows what she's talking about.
When I worked in the industry, we used to call what became CDO/CLOs "kitchen sink deals." It was how you got all the garbage off your balance sheet that you couldn't sell directly to investors as is. You wrapped it up, put a new payment structure on top to get the ratings and then you were only stuck with the tail/equity piece as opposed to tying up your balance sheet with the whole lot. The next few months should be interesting.
The more I read about these things, the more I think maybe David Pearson's comments in an earlier thread deserve some thought. What if there is a developing lack of confidence (already begun, in fact?) that leads to what would have been called a 'run on the banks' in earlier times.... but these are not banks and are not equipped to deal with that sort of thing. There is no insurance, no Federal backing, no reserve requirement... and the reply to investors that withdrawals are prohibited until further notice would turn a rout into a riot.
Stay with the long posts, Tanta. They are calisthenics for my aging brain, and without them I know I'd be complete mush right now. I often don't understand 80% of them, but they're stimulating the ol' neurons anyway.
But, of course, your forte is in your humor. That's the junk food, and it's fun.
I can't be the only one who suspects that "illiquidity" is in some quarters the new term for "I don't like the bid."
Tanta, Bill Gross of PIMCO thinks the same thing. In an interview Mr. Goss mentioned that PIMCO placed bids in the 'upper 90 cents on the dollar' for some of the Bear-Sterns paper and was turned away. I guess BS was expecting more like 102 cents on the dollar!!
It's the same old story and methods as when the "establishment" and it's favorite whore, the "press" keep repeating story after story about all these degenerate, corpulent, grease-stained, sneering, "foreign" drug barons, with their harems of sleezy whores and their equally sleezy henchman who "poisonning" are poor, innocent youth and destroying their own innocent victim "paisons".
All the better to keep us from thinking about, from "seeing" the reality -- the high finance machinery that makes the drug trade possible, or the government enablers of all nationalities, or of the nattily-attired Wall street types and their "nice" kids who keep getting caught with their beemers full of cocaine, heroin, ecstasy, and all the other "pharmaceutical vacation plans" for which the idle and dim-witted "high society" seems to have no lack of need.
That is, until like Paris Hilton, they get busted and have to do a little jail time and they suddenly find God and Environmetalism. Poor Paris, gotta sit on a dirty, open-air potty in front of everybody just like all those other, evil, gangland drug lords! It must have killed you to think that God would do such a thing to you!
What makes me think there might be some scapegoating going on? I'm not claiming that there are no troubles in Subprime City, of course. I am simply having a hard time reconciling the claim that there is a simple and uncomplicated relationship between these hedge funds' CDO asset valuation meltdowns, on the one hand, and deterioration in subprime mortgage performance on the other, when at the very same time this claim is made, we are informed that CDO portfolios are opaque, no one knows what's in them, and what we do know suggests that subprime ABS tranches cannot possibly be the largest share of their holdings
Thank you Tanta I have been saying the exact same thing for months....spot o
SteveB doesn't speak for most of us. Your articles are great. If we wanted newsclips we would just read the headlines off of Bloomberg. I heart the detail and your excellent writing
Here Here...ill take the long educated post...thank you
With all the technology and computers available to just about everyone these days the old fashioned financial markets -- you know those that are actually, clearly, openly, tied to some real kind of value such as assests, productive capacity, resources, food, shelter, shoes, bow-n-arrows and spears and mastodon steaks, etc -- could no longer enjoy the advantage of their secret, clubby, insider cabals, their "ineffecient market", to rake in the easy and super big dough! Why, hell, just about anybody with the time and smarts to study a little bit about finance and markets could get all the up-to-date info and what the markets were doing and have an equal chance of getting their share of the pie. THE MARKET AND FINANCAIL WORLDS BECAME VERY, VERY EFFECIENT -- THE SPREADS AND OPPORTUNITIES TO MAKE BIG AND EASY KILLINGS WERE GONE -- that is, without huge effort and risk such as actually creating and bringing to market a product -- you know -- CAPITALISM, RISK! Or without, "cough, cough, sputter", BREAKING THE LAW!
Wall Street, High-Finance, has always been about who controls the information, who controls, has access to, can act on, the secret insider information while keeping everyone else in the dark while picking their pockets. Admam Smith! Hah! what a laugh, what a nieve opium smoker! When technology allowed the semi-intelligent, semi-educated man-in-the-street to have a crack at the game, the Good-Ole-Boy regime had to come up with other methods of pulling the wool over everybody and getting a leg up! Anti-Insider Trading laws???? Hah, the whole game is BASED on insider trading! It's all about GAMING the system to rake in billions while the masses toil in the fields for left-over spuds and turnips! Just look at the carry trade and RENT SEEKING environment -- it's all about being the middleman (or the gatekeeper), especially if you can have a government guarenteed middleman position with no RISK and INFINITE OPPORTUNITY to COLLECT RENT.
Far easier to get your own people into the houses of power, BY ANY MEANS POSSIBLE, change those laws, BY ANY MEANS OR EXCUSES POSSIBLE, so that what was once illegal and unethical, what was once clearly understood as SCAMMING, LYING, and FRAUD, becomes a perfectly acceptable, everyday means of doing business. CORRUPTION BECOMES THE NORM, NON-PRODUCTIVE, ASSEST GRABBING BECOMES THE NORM, MONEY BECOMES A MEANINGLESS VALUELESS FANTASY.
Is there anybody able to type on a computer keyboard that doesn't understand this????
Here are a few things that should help:
- CDO squared/cubed just means CDOs structured with CDOs as the asset (i.e. squared). Cubed would be CDOs structured with CDOs structured with CDOs.
- Yes, subprimes are a problem but mostly it is because these CDOs are ridiculously leveraged that is the real problem. As the myriad of assets that are backing these structured securities (subprime mortgages being one asset) started to lose value, the banks that were on the hook (i.e. those providing leverage) started to check their books. As asset values started to decline, and it doesn't take much, banks started to make margin and valuation reset calls; they basically made liquidity checks. Since these funds were so leveraged, it obviously becomes extremely difficult to meet these levels; again, it is obvious that providing liquidity with another product that needs to provide liquidity is difficult.
- the largest problem with have with subprimes is with the media. They have no idea and is causing hysteria amongst people that have no business being hysterical. Yes, defaults are high. Yes, people got screwed. But also, Yes, this problem is contained. These securities are all 144a, which simply means that people that invest are "highly sohphisticated" investors; i.e. large funds and rich people. These funds should not be transparent if they do not want to be. These investors are supposed to be smart people that are making the investment decisions. What we have here are nothing but stupid rich people and unethical investment banks. These structured instruments are toys of the "sophisticated" and if they want to play in this game, it's their problem.
- Don't worry, your next door neighbor will not be homeless. Let's just hope our 401k/pension /mutual funds have not lost their "sophisticated" brains.
Tanta knows how to write a short post when it increases transparency, as in this classic summary of Bernanke's May 17 remarks:
"CR quoted the first paragraph. Here's how the rest of it goes:
Technology lets us find more subprime borrowers faster.
Securitization lets us find more bagholders faster.
We made a lot more loans this way.
Ownershipsocietyminoritypoorpeoplehelpedfeelgood.
Somehow, subprime borrowers still default more than prime borrowers do.
Number 6 is a recent problem.
ARMs have rates that go up, and home prices don't always rise. This is new, too.
Some of that loan underwriting was also kind of sucky.
It paid to make junk loans if you didn't have to own them.
Apparently some borrowers didn't get the memo.
Hedgies are bailing out the CDOs, so there's still some party left in the punchbowl. So far the banks can pass a breath test.
Even though this isn't a bank problem, the Fed is working with banks to help solve it.
We think someone should buy out those crappy securities and start modifyin', baby.
For some reason these borrowers think the lenders want to foreclose. Sure, it looked that way when the loan was made, but it's different now. Please call your lender, it's ready to make nice.
We're snorting a fine line here.
17-22. The best solution is to disclose to the borrower that these loans rarely make sense. It would be bad to ban them entirely, because they often do make sense.
23-24. We are also guiding the underwriting of the banks that aren't the ones making these loans.
25-26. None of this will affect the home market unduly, because jobs and wages will go up.
27-28. The market will correct any problem we can't mop up with disclosure requirements."
I say keep 'em coming, Tanta, and you choose the length.
Scapegoating of subprime has been , IMO, the route that the powers that be have decide to take to "contain" the problem and stall further panic. Even to the extent that within subprime, they've laid most of the blame on "minorities", translate to "inherently ignorant, poor people who are clueless about finances".
Easy to do in a society with classist and racist underpinnings.
It's working pretty well so far I think as most people are now aware of the "subprime problem" but, despite the fact that they may personally know a white, middle class individual or two who is or has experienced difficulty, they continue to believe that it is mainly confined to a small "minority" segment of society.
Frankly, I think the MSM has done a brilliant snow job with this one.
Thankyou for pointing out the basic problem Tanta.
While it's difficult to get, street research from Credit Suisse and Barclay's (among others) have compiled data on the number of CDOs that have subprime securities holdings.
Some mortgage ABS are more liquid than others, and the "subordinate" bonds have always been more liquid than the senior bonds. CDO's over the past two years bought the vast bulk of BBB/BBB- tranches from subprime ABS over the past two years. By far.
Because these so-called "mezz" bonds are very cuspy, the recent housing downturn has made it likely that a decent of BBB- (and quite a few BBB) subprime bonds issued last year will take principal writedowns -- in some cases all of it! However, performance across issues is vastly different, so...
In some CDOs, the cash flow "waterfall" is dependent not just on the performance of the underlying loans backing the securities, but also on the timing of rating agency downgrades (PIK-ables). Modeling rating agency actions is a crapshoot.
Net: Subordinate subprime bonds have always been a bit illiquid, but (1) because CDO subprime holdings are mainly BBB/BBB-, and (2) many of those bonds look like they'll take principal hits, but it varies massively and is highly dependent on future home prices; and (3) the structure of some subprime mezz CDOs is "whacky", than it's no surprise that these bonds have become so illiquid.
And, of course, investors have lost all faith in rating agencies.
There are estimates that the global hedge fund size is US$ 1 trillion, so you would think the industry could stomach a $40 billion haircut. But what at one point may just be a liquidity issue can become a confidence issue.
If that happens and all these "smart" investors(which include pension funds seeking alpha) run towards the exits, the run on the hedges leads to a rout in equities/bonds/anything.
So (possibly), your (allegedly) greatest store of value, your home, takes a haircut; your 401k nest egg takes a haircut because you went to cash equivalent because it's in a stable value fund backed by CDOs instead of a money market; and your stocks & bonds have gotten whacked because the hedgies had to liquidate positions to meet withdrawls.
All I know is that I'm grateful that our muni bonds our in our name and we have recourse through the courts instead of arbitration.
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.
Hear, hear! Or is it here, here?? Or maybe a little of both since, it comes to CDOs, it appears there may be no there there. Anyway, I couldn't agree more, MOM. ;>)
Despite the abundance of highly intelligent and knowledgeable individuals posting comments here, Tanta's the only one consistently expanding my mind. Keep up the great work, Tanta -- I'll read every word you write, regardless of length.
Regarding opacity... Wall Street is saying "Give me your money and go away."
Regarding liquidity... if every dollar is leveraged 10x, then 90% of the market is smoke & mirrors and can disappear over night.
Regarding CDOs... I still think Tanta's right in that non-agency MBS are not viable in a normal market. Therefore the CDOs were nuclear waste from the word go. No amount of maturity will fix that.
I think the liquidity label has more to do with the fact that these aren't commodities and that the "sales cycle" can take a long time because people need to get in there and dig around to figure out what it's worth. (You don't have to do that with dollars or oil or shares of General Electric because, well, they are very liquid. There's a constant trade and a constant repricing.)
Houses are also not liquid, nor did they magically become liquid during the boom. Sellers liked the bids during the boom and the assets did sell faster, but it certainly wasn't a liquid market. Same here.
Liquidity (or lack thereof) isn't an excuse for not liking the bid. Not liking the bid IS an excuse for choosing not to sell.
The really delicious part about this whole mess is that the Wall Street firms cooked up these securities so they could pawn off some really bad stuff on the hedge funds that were demanding more return. And once they saw how much the hedge funds were liking it, they said: I want some of that too!!
The right hand forgot that the left hand had spiked that wonderful concoction with poison.
It would be the perfect schadenfreude moment, except that when Bear Stearns and Lehman fail, a lot of innocent people (like the loyal readers of this blog) will get crushed.
Godda*m Tanta, you are in fine form lately. I haven't seen a knife fillet an exposed flank this cleanly in quite a while. Not to insult, but there are some lawyers out there who could benefit from the art of your dissection. Keep it up girl. I stand aside.
It's late, I'm tired and I'm pretty heavily medicated, so I really am in no condition to make heads or tails of this post at the moment, but somehow I feel the gist of it is contained in these two sentences:
Generating a jillion-gigawatts of power is always a blast. Figuring out what to do with all the leftover plutonium-239 is a drag.
I'll read it again in the morning. Even if I still can't figure it out, those two sentences are ones I'll always keep in mind when someone talks to me about some harebrained scheme.
Thanks Tanta and CR, without you, the current less would be both more murky and less fun.
From 04 to 06 I was involved in many Subprime, ABS, ABS CDO transactions and I am sure that most of the buyers (long/short) of these risks had no idea of what the hell they were getting into. I remember a Japanese investor that did not even understand English buying the equity tranche of an ABS CDO,.... Keep in mind most ABS market participants are bond traders at best and have no idea of the derivative nature of the business.
There is now an active market on Subprime Correlation risk (TABX), and I am more interested in seeing how much and how well people are engaging in this product. How do you determine the default correlation of a New Century pool of loans with a Countrywide pool of loans...And yes it's the same cash bond traders that are now using gaussian copula to trade these instruments.
Nouriel Roubini might have been your only comrade in arms as far as sounding the alarm early on alt-A.
As to your questions about illiquidity: I remember the old junk bond days. At the worst of it (1990) it would be hard to get any bids at all for lesser-known pieces. Information was usually there though because most issuers reported to the SEC.
Contrast this to the current MBS markets. I don't doubt you can get all the prospectuses and documentation you want on plain vanilla GSE paper. But as you say -- if info is that hard to come by on individual securities, bids will be too. Another comparison: you would expect security analysts to cover junk bond companies -- and bond analysts to cover GSE paper -- but who would have published opinions on these little private MBS deals? My guess? Fuggedaboutit!
Excellent post Tanta!
And how about this little jewel:
Since such instruments typically last three to five years and the CDO boom is so recent many have not come to the end of their life.
Don't ask me what "typically" might mean when it is followed by "the CDO boom is so recent." I certainly hope it doesn't mean "our CPR models told us this stuff would pay off so fast that we'd never be stuck with a duration problem." Or, perhaps, "we assumed we could force the MBS issuer to call the underlying security even when the issuer is not obligated to and it is not "economic" for the issuer to do that."
Great post. Fantastic. Loved your point that illiquidity/low transparency is a feature, not a bug. It was designed to be this way.
Let's face it: hedge funds and other participants are trying to make money on the parts of the market that are harder to figure out, because they're (allegedly) "smarter." As risk premiums came down, the Street found a way to create product for those demanding it: complicated, illiquid and untransparent.
This paper was created precisely for those who wanted to skate on the edge, precisely at the time when everyone collectively decided they wanted to skate on the edge too, by those who make money sharpening the skates. And now it's the pond's fault.
Or some other better analogy.
Great post and comments. Lord help us...
Tanta, another excellent post. I would describe this not as "the worm turning", but as "intelligence returning".
It seems odd to write this now, but very recently the markets knew how to write loans relatively cheaply and relatively safely, and I think we can all dig deep and remember how. If not, we have you to remind us!
we've innovated our way into a situation in which nobody has the first bloody idea what's going on with the securities they're in or the CDOs that buy the tranches of the securities or the hedge funds that buy the tranches of the CDOs of the securities of the mortgages that were written on a hope and a prayer and a FICO.
Any time an investment is opaque it's really a violation of free market rules. I think we have to look at what has worked in the past - reasonable regulation - and then figure out how to apply reasonable regulation in the present. What angers me the most is that those who should be arguing for that regulation (I am talking Paulson and that lovely hedge fund "guidance" of a few months ago) are the people trying to further muddy the waters.
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.
my favorite quote from the financial internets this quarter: liquidity=trust
Yal et al,, when you say lenders to look at for shorting/puts -- are you talking about the WaMu, Countrywides of the world?
This paper was created precisely for those who wanted to skate on the edge, precisely at the time when everyone collectively decided they wanted to skate on the edge too, by those who make money sharpening the skates. And now it's the pond's fault.
How about this: the paper was created for those who want to feed on the bottom. So after everyone jumped into this Big Muddy River and thrashed around for a while, they're now complaining that the water's too murky to see through.
Or maybe it's just a bunch of kiddies who peed in the swimming pool. These analogies become dangerous . . .
Tanta. Your articles are good, but I think much too long for some of us. As a result, I stopped reading them. Please consider editing them to a much shorter length.
Is there any sort of chart of when these CDOs start to "come to the end of their life" ? It would seem that it is going to be very interesting when these things start to become 'unmade'. Maybe they won't be the only things getting 'unmade'.
Tanta,
SteveB doesn't speak for most of us. Your articles are great. If we wanted newsclips we would just read the headlines off of Bloomberg. I heart the detail and your excellent writing.
Tanta
I understood the problem with these mortgages over 2 1/2 years ago, because of people like Bill Bonner at Lew Rockwell.com. The problem is the MSM feeds the public a diet of spin and misinformation that is so dense the public can't hack through it to find the truth. We have to face the fact that Paris Hilton gets more coverage on TV than foreclosures, the real estate downturn, or CDOs. The vast majority of the peole I know still think that real estate only goes up, and don't get me started on my inlaws.
Thanks, Unkown2.
steveb, you're fighting a losing battle. Just about every time I do a long post I get at least one person complaining that it was too long, followed by at least one and usually several loyal CR readers piling onto that comment to the effect that people come here for long, detailed stuff.
Besides the fact that there are many, many places on the net you can get the short version, but only a few where you get the drill-down, I want to point out that the whole gist of the post is that shorthand arguments--"the hedge fund meltdown is about bad subprime paper"--are hard to kill precisely because it takes more than a few sentences to explain what the problem is, and in our attention-span-deprived world most journalists won't devote more than a few sentences to anything.
Please stay with the longer postings. I often skip them, because I don't have time to read them. But when I do have time, they are worthwhile and I learn some things. Plus, they make good reference material...
"Tanta. Your articles are good, but I think much too long for some of us. As a result, I stopped reading them. Please consider editing them to a much shorter length."
Disagree. Too short. I like a Tanta blog entry that takes approximately my lunch hour to absorb. Tanta's entries get me through my first pre-lunch smoke.
I can't be the only one who suspects that "illiquidity" is in some quarters the new term for "I don't like the bid."
Another classic quote for the stonemason to engrave over the mantlepiece.
"There are just too many notes. Take out a few"
"Which ones would you suggest, your Majesty?"
One of your best articles ever, Tanta, saying oh so many things that really need to be said.
I believe the opacity is very much by design, and that these securities are a direct analog to Enron's opaque "Special-Purpose Entities". The hedgies need securities which they can "mark to model" (again like Enron) so as to support claims of huge short-term profits from which to take their 20% cut, while maintaining plausible deniability to avoid imprisonment and clawback of the profits by the marks' lawyers in the long term. Opacity serves both ends.
That deregulation has resulted in a situation in which none of the bank regulatory agencies can evaluate the securities is both horrifying and hilarious. The end result, of course, will be awesome financial carnage and reimposition of the kind of regulations that used to prevent this.
It is wonderful that you remind everyone that for decades we managed to have a smoothly functioning mortgage financing system without any of this Absolute Bull S**t.
"There are just too many notes. Take out a few"
"Which ones would you suggest, your Majesty?"
An "Amadeus" reference?
And definitely not too long.
You're so right -- an illiquid market is one in which you don't like the bid!
I think the thing to keep in mind is that CDO's have manufactured demand for the underlying paper. When I say manufactured, I mean that because of leverage, a hedge fund or pension fund was buying more paper in a CDO than they would have bought directly. This accounts for the originators' attitude towards 'snow doc' lending: it wasn't that they were so stupid, its just that its what they HAD TO DO to keep up with demand for securitizations.
The point is that slowing demand for CDO's means new demand for mortgage securitizations should fall quicker than you can say "illiquid". That's the important thing: no CDO's, no demand for 'snow docs', tighter standards. Not because the originators are all of a sudden smart, but because that's what they HAVE TO DO to keep up with falling demand.
A) I actually read Tanta first, so up the votes for length.
B) More drink recipes please: I simply can't cope with the state of the economy and the actions of the Bush admin and judiciary in the same space-time locus, not without help.
Dear Tanta,
Thanks, I try to read and learn illuminating.
Seems like a case of Hey the IT guys and mathematicians have models that say we will make money! Lets do it!
But, gee whiz, the models were only set for three years.
Regards,
Tanta, I echo the encouragement to stay with the long posts. The MSM is the one that has to stick with sound bites so that a dumbed-down public with a short attention span won't change the channel.
This is not an MSM audience. I especially hearing at length from someone who obviously knows what she's talking about.
Um, that was supposed to be "especially appreciate hearing"
When I worked in the industry, we used to call what became CDO/CLOs "kitchen sink deals." It was how you got all the garbage off your balance sheet that you couldn't sell directly to investors as is. You wrapped it up, put a new payment structure on top to get the ratings and then you were only stuck with the tail/equity piece as opposed to tying up your balance sheet with the whole lot. The next few months should be interesting.
The more I read about these things, the more I think maybe David Pearson's comments in an earlier thread deserve some thought. What if there is a developing lack of confidence (already begun, in fact?) that leads to what would have been called a 'run on the banks' in earlier times.... but these are not banks and are not equipped to deal with that sort of thing. There is no insurance, no Federal backing, no reserve requirement... and the reply to investors that withdrawals are prohibited until further notice would turn a rout into a riot.
Stay with the long posts, Tanta. They are calisthenics for my aging brain, and without them I know I'd be complete mush right now. I often don't understand 80% of them, but they're stimulating the ol' neurons anyway.
But, of course, your forte is in your humor. That's the junk food, and it's fun.
Expired
just a decent summary of all things housing- they lead with a Bob Troll quote.
I can't be the only one who suspects that "illiquidity" is in some quarters the new term for "I don't like the bid."
Tanta, Bill Gross of PIMCO thinks the same thing. In an interview Mr. Goss mentioned that PIMCO placed bids in the 'upper 90 cents on the dollar' for some of the Bear-Sterns paper and was turned away. I guess BS was expecting more like 102 cents on the dollar!!
Another possible analogy - you can't run a shell game with transparent shells.
Tanta,
It's the same old story and methods as when the "establishment" and it's favorite whore, the "press" keep repeating story after story about all these degenerate, corpulent, grease-stained, sneering, "foreign" drug barons, with their harems of sleezy whores and their equally sleezy henchman who "poisonning" are poor, innocent youth and destroying their own innocent victim "paisons".
All the better to keep us from thinking about, from "seeing" the reality -- the high finance machinery that makes the drug trade possible, or the government enablers of all nationalities, or of the nattily-attired Wall street types and their "nice" kids who keep getting caught with their beemers full of cocaine, heroin, ecstasy, and all the other "pharmaceutical vacation plans" for which the idle and dim-witted "high society" seems to have no lack of need.
That is, until like Paris Hilton, they get busted and have to do a little jail time and they suddenly find God and Environmetalism. Poor Paris, gotta sit on a dirty, open-air potty in front of everybody just like all those other, evil, gangland drug lords! It must have killed you to think that God would do such a thing to you!
Pox on all of them!
What makes me think there might be some scapegoating going on? I'm not claiming that there are no troubles in Subprime City, of course. I am simply having a hard time reconciling the claim that there is a simple and uncomplicated relationship between these hedge funds' CDO asset valuation meltdowns, on the one hand, and deterioration in subprime mortgage performance on the other, when at the very same time this claim is made, we are informed that CDO portfolios are opaque, no one knows what's in them, and what we do know suggests that subprime ABS tranches cannot possibly be the largest share of their holdings
Thank you Tanta I have been saying the exact same thing for months....spot o
SteveB doesn't speak for most of us. Your articles are great. If we wanted newsclips we would just read the headlines off of Bloomberg. I heart the detail and your excellent writing
Here Here...ill take the long educated post...thank you
Tanta, you are a gem.
Best blogger on the internet.
Isn't it all so blindinly obvious!
With all the technology and computers available to just about everyone these days the old fashioned financial markets -- you know those that are actually, clearly, openly, tied to some real kind of value such as assests, productive capacity, resources, food, shelter, shoes, bow-n-arrows and spears and mastodon steaks, etc -- could no longer enjoy the advantage of their secret, clubby, insider cabals, their "ineffecient market", to rake in the easy and super big dough! Why, hell, just about anybody with the time and smarts to study a little bit about finance and markets could get all the up-to-date info and what the markets were doing and have an equal chance of getting their share of the pie. THE MARKET AND FINANCAIL WORLDS BECAME VERY, VERY EFFECIENT -- THE SPREADS AND OPPORTUNITIES TO MAKE BIG AND EASY KILLINGS WERE GONE -- that is, without huge effort and risk such as actually creating and bringing to market a product -- you know -- CAPITALISM, RISK! Or without, "cough, cough, sputter", BREAKING THE LAW!
Wall Street, High-Finance, has always been about who controls the information, who controls, has access to, can act on, the secret insider information while keeping everyone else in the dark while picking their pockets. Admam Smith! Hah! what a laugh, what a nieve opium smoker! When technology allowed the semi-intelligent, semi-educated man-in-the-street to have a crack at the game, the Good-Ole-Boy regime had to come up with other methods of pulling the wool over everybody and getting a leg up! Anti-Insider Trading laws???? Hah, the whole game is BASED on insider trading! It's all about GAMING the system to rake in billions while the masses toil in the fields for left-over spuds and turnips! Just look at the carry trade and RENT SEEKING environment -- it's all about being the middleman (or the gatekeeper), especially if you can have a government guarenteed middleman position with no RISK and INFINITE OPPORTUNITY to COLLECT RENT.
Far easier to get your own people into the houses of power, BY ANY MEANS POSSIBLE, change those laws, BY ANY MEANS OR EXCUSES POSSIBLE, so that what was once illegal and unethical, what was once clearly understood as SCAMMING, LYING, and FRAUD, becomes a perfectly acceptable, everyday means of doing business. CORRUPTION BECOMES THE NORM, NON-PRODUCTIVE, ASSEST GRABBING BECOMES THE NORM, MONEY BECOMES A MEANINGLESS VALUELESS FANTASY.
Is there anybody able to type on a computer keyboard that doesn't understand this????
Agreed on the hooray for long posts. Also agree that newspapers are a lousy medium for lengthy, subtle, nuanced thought.
Here are a few things that should help:
- CDO squared/cubed just means CDOs structured with CDOs as the asset (i.e. squared). Cubed would be CDOs structured with CDOs structured with CDOs.
- Yes, subprimes are a problem but mostly it is because these CDOs are ridiculously leveraged that is the real problem. As the myriad of assets that are backing these structured securities (subprime mortgages being one asset) started to lose value, the banks that were on the hook (i.e. those providing leverage) started to check their books. As asset values started to decline, and it doesn't take much, banks started to make margin and valuation reset calls; they basically made liquidity checks. Since these funds were so leveraged, it obviously becomes extremely difficult to meet these levels; again, it is obvious that providing liquidity with another product that needs to provide liquidity is difficult.
- the largest problem with have with subprimes is with the media. They have no idea and is causing hysteria amongst people that have no business being hysterical. Yes, defaults are high. Yes, people got screwed. But also, Yes, this problem is contained. These securities are all 144a, which simply means that people that invest are "highly sohphisticated" investors; i.e. large funds and rich people. These funds should not be transparent if they do not want to be. These investors are supposed to be smart people that are making the investment decisions. What we have here are nothing but stupid rich people and unethical investment banks. These structured instruments are toys of the "sophisticated" and if they want to play in this game, it's their problem.
- Don't worry, your next door neighbor will not be homeless. Let's just hope our 401k/pension /mutual funds have not lost their "sophisticated" brains.
Fed repeats inflation still predominant policy concer
Tanta knows how to write a short post when it increases transparency, as in this classic summary of Bernanke's May 17 remarks:
"CR quoted the first paragraph. Here's how the rest of it goes:
17-22. The best solution is to disclose to the borrower that these loans rarely make sense. It would be bad to ban them entirely, because they often do make sense.
23-24. We are also guiding the underwriting of the banks that aren't the ones making these loans.
25-26. None of this will affect the home market unduly, because jobs and wages will go up.
27-28. The market will correct any problem we can't mop up with disclosure requirements."
I say keep 'em coming, Tanta, and you choose the length.
Calculated Risk: Bernanke: The Subprime Mortgage Market
I'm sure that the mortgage mess will be contained to dealing with the $6 trillion or so in bogus "equity wealth" it spawned across the land.
Scapegoating of subprime has been , IMO, the route that the powers that be have decide to take to "contain" the problem and stall further panic. Even to the extent that within subprime, they've laid most of the blame on "minorities", translate to "inherently ignorant, poor people who are clueless about finances".
Easy to do in a society with classist and racist underpinnings.
It's working pretty well so far I think as most people are now aware of the "subprime problem" but, despite the fact that they may personally know a white, middle class individual or two who is or has experienced difficulty, they continue to believe that it is mainly confined to a small "minority" segment of society.
Frankly, I think the MSM has done a brilliant snow job with this one.
Thankyou for pointing out the basic problem Tanta.
Net: Subordinate subprime bonds have always been a bit illiquid, but (1) because CDO subprime holdings are mainly BBB/BBB-, and (2) many of those bonds look like they'll take principal hits, but it varies massively and is highly dependent on future home prices; and (3) the structure of some subprime mezz CDOs is "whacky", than it's no surprise that these bonds have become so illiquid.
And, of course, investors have lost all faith in rating agencies.
There are estimates that the global hedge fund size is US$ 1 trillion, so you would think the industry could stomach a $40 billion haircut. But what at one point may just be a liquidity issue can become a confidence issue.
If that happens and all these "smart" investors(which include pension funds seeking alpha) run towards the exits, the run on the hedges leads to a rout in equities/bonds/anything.
So (possibly), your (allegedly) greatest store of value, your home, takes a haircut; your 401k nest egg takes a haircut because you went to cash equivalent because it's in a stable value fund backed by CDOs instead of a money market; and your stocks & bonds have gotten whacked because the hedgies had to liquidate positions to meet withdrawls.
All I know is that I'm grateful that our muni bonds our in our name and we have recourse through the courts instead of arbitration.
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.
Hear, hear! Or is it here, here?? Or maybe a little of both since, it comes to CDOs, it appears there may be no there there. Anyway, I couldn't agree more, MOM. ;>)
Despite the abundance of highly intelligent and knowledgeable individuals posting comments here, Tanta's the only one consistently expanding my mind. Keep up the great work, Tanta -- I'll read every word you write, regardless of length.
Regarding opacity... Wall Street is saying "Give me your money and go away."
Regarding liquidity... if every dollar is leveraged 10x, then 90% of the market is smoke & mirrors and can disappear over night.
Regarding CDOs... I still think Tanta's right in that non-agency MBS are not viable in a normal market. Therefore the CDOs were nuclear waste from the word go. No amount of maturity will fix that.
I think the liquidity label has more to do with the fact that these aren't commodities and that the "sales cycle" can take a long time because people need to get in there and dig around to figure out what it's worth. (You don't have to do that with dollars or oil or shares of General Electric because, well, they are very liquid. There's a constant trade and a constant repricing.)
Houses are also not liquid, nor did they magically become liquid during the boom. Sellers liked the bids during the boom and the assets did sell faster, but it certainly wasn't a liquid market. Same here.
Liquidity (or lack thereof) isn't an excuse for not liking the bid. Not liking the bid IS an excuse for choosing not to sell.
The really delicious part about this whole mess is that the Wall Street firms cooked up these securities so they could pawn off some really bad stuff on the hedge funds that were demanding more return. And once they saw how much the hedge funds were liking it, they said: I want some of that too!!
The right hand forgot that the left hand had spiked that wonderful concoction with poison.
It would be the perfect schadenfreude moment, except that when Bear Stearns and Lehman fail, a lot of innocent people (like the loyal readers of this blog) will get crushed.
Godda*m Tanta, you are in fine form lately. I haven't seen a knife fillet an exposed flank this cleanly in quite a while. Not to insult, but there are some lawyers out there who could benefit from the art of your dissection. Keep it up girl. I stand aside.
It's late, I'm tired and I'm pretty heavily medicated, so I really am in no condition to make heads or tails of this post at the moment, but somehow I feel the gist of it is contained in these two sentences:
Generating a jillion-gigawatts of power is always a blast. Figuring out what to do with all the leftover plutonium-239 is a drag.
I'll read it again in the morning. Even if I still can't figure it out, those two sentences are ones I'll always keep in mind when someone talks to me about some harebrained scheme.
Thanks Tanta and CR, without you, the current less would be both more murky and less fun.
please insert the word mess above between the words current and less in the last sentence.
Someday I'll learn to use that preview button.
And I'll bet "jillion-gigawatts" means Tanta is one of those few who know the initial "g" in giga is properly soft.
From 04 to 06 I was involved in many Subprime, ABS, ABS CDO transactions and I am sure that most of the buyers (long/short) of these risks had no idea of what the hell they were getting into. I remember a Japanese investor that did not even understand English buying the equity tranche of an ABS CDO,.... Keep in mind most ABS market participants are bond traders at best and have no idea of the derivative nature of the business.
There is now an active market on Subprime Correlation risk (TABX), and I am more interested in seeing how much and how well people are engaging in this product. How do you determine the default correlation of a New Century pool of loans with a Countrywide pool of loans...And yes it's the same cash bond traders that are now using gaussian copula to trade these instruments.