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Hi
I love coming by here it always makes me feel better. I won't feel bad for any of them when they start jumping out the windows. I just wonder how many of them know the glass is thick and it doesn't open, I guess we'll find out by hospital numbers of those injured when they bounce back. Sure hope the medical is paid up. Oh well back outside to get next years garden area ready.
jo6pac
I agree that things are a whole lot worse than anyone is letting on. This should be a huge opportunity to load on the shorts but the problem is that until it matters it doesn't, and in the meantime you get killed. Its also not fun always being the party pooper. I'm thinking about just drinking the kool-aid and partying 'cause it just never seems to end.
Please someone tell me how I can benefit (er, profit) from this information (to which I agree with the interpretation almost always)? Although I am specifically referring to this particular blog entry, I really want to understand the potential benefit from the overall content on this site.
Should I be buying something now? Should I be selling something now?
Should I be saving my money to buy at some point in the future [and will we recognize this moment when it is upon us]?
Any AAA, AA, A or whatever rating that's based on insurance may not be worth the paper it's written on.
Including Munis. Look, they aren't going to allow you to repossess a sewer system and run it to get your money back. California particularly is set to be repudiating any number of "insured" debt instruments. Shoe two to drop.
I think things will get worse before they get better for structured credit products. That said, Bond Insurers tend to insure only the very safest tranches of ABS and MBS. These tranches may be getting written down at Merrill, but that doesn't mean they're going to default. Its only if they default that the Bond Insurers would be in any kind of trouble. That's possible I guess, but still seems pretty remote - and I'm usually the cynic.
The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon.
"There's a comment in Barron's this week the MGIC guaranteed 27% of the debt in Alt-A mortgages. Need I say more?"
JBA
MGIC are very different from bond insurers like MBIA or Ambac. MGIC provide private mortgage insurance. I'm not sure if you were responding to my post.
The one odd thing about the whole credit/housing melt-down is that the more the problems become acknowledged, the greater becomes the delusion about the consequences...
CR,
In case you're looking for a new bubble to follow in a year or so, I suggest alpacas!
They are basically being bred to sell as breeders. A female might fetch $10-20,000, a male with a good bloodline can command $100,000+.
But the only sustainable thing they can be raised for is their wool, but that would return about the cost of feed, shelter and medical care.
It's an incredible pyramid that will crash spectacularly. Imagine if condos in Miami actually reproduced, that's the alpaca market in a nutshell.
I wish there were a market in alpaca puts... Maybe there will be a new ETF..
Do you think that if AIG went bankrupt that might send the Dow down a bit, for a week or so? Or would it jump up, with a hysterical sigh of relief, as it did with MER?
The model for municipal bond insurance has always been that it will work in all environments except a hundred-year flood. So, even if the muni insurance companies didn't have all the mortgage and derivatives exposure (which is big), they would be vulnerable in a severe once-per-century credit crunch. Now, they are about to get hit on both sides at once.
The market has always believed governments can support GO bonds with their taxing power. But Orange County couldn't in the 90s because of a taxpayer revolt. There will be more revolts, but the biggest vulnerability is the massive amounts of industrial development bonds and revenue bonds that don't have taxing power. Many are insured. Defaults among IDBs and revenue bonds will be one of the biggest stories of 2008 and it will take down at least one muni bond insurer. As Fleck says, that will trigger downgrades in all bonds that carry the same insurance. (The insurance is permanent for the life of the bond.)
I guy I know asked me about alpacas, I told him it was a cross between MLM and condos, and for what a female costs he could plant his TN acreage in heirloom fruit trees and have $5k left over and his maint. costs would be less than the $5000 by the time they started bearing fruit and paying for themselves. The farming gives him a tax break and his upfront money can be invested in laddered CDs.
He starts planting next month, has been talking to upscale restaurants to gauge future interest.
It ain't a grand slam, but it'll be a nice double, especially when the specuvestors behind his land(without water or sewer access) get blown out and he picks up their pieces.
"But at this point, Radian looks like the better bet than MGIC. For one thing
Radian has two business lines rather than one. Moreover, MGIC's dollar-loss
per claim is going up faster than Radian's. That's because Radian shrewdly
capped its loss exposure on its Alt-A mortgages to just 14% of the unpaid
principal, while MGIC is paying out on over 27% of Alt-A mortgage losses.
What makes that category so lethal is the fact that the size of these
generally "no documentation" mortgages is so much larger than subprime
mortgages.
Conditions in the mortgage market won't improve for many quarters. But a
pair trade involving going long Radian and selling short MGIC might well
work out while panic reigns."
The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon.
Seems like a price that just caused me change my shorts
Dryfly LOL! Took me a minute to figure it out, but then I laughed.
Doc Zoid, the ABX.HE indexes are for MBS, not CDOs. But the news about the AAA CDO downgrades probably hurt ABS. Btw, intraday got below 82 for AAA 07-1.
Christmas season is approaching and I need to know how much longer China can follow our currency down!
Stagflationary Mark | Homepage | 10.27.07 - 4:35 pm | #
I think it's pretty simple but that's just me a few others.
Think Summer Olympics, then BYE,BYE Dollar
jo6pac
FT - Doubts emerge over guarantors' creditworthiness (MBIA & AMBAC)
"The perceived creditworthiness of two of the largest financial guarantors in the US on Thursday plunged to lows not seen since the worst of the credit squeeze in August." FT.com / Capital Markets - Doubts emerge over guarantors’ creditworthiness
"The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon."
--tis but a flesh wound, said the black knight ...
To some extent therefore the price of complex derivatives can be compared to what happens in any fish market. If for any reason no buyer shows up, prices of fresh fish fall dramatically as they have to be sold as either frozen food or worse, as fish feed. That leaves very little room for maneuver for the average fisherman.
The world of investment banking, by creating increasingly complex products, also went down this same path wherein demand for its products was the only real proof of prices ever available. In other words, the fact that an investor bought a security from you at say 100 meant that the value of the security was 100. If there was no investor, then by logical deduction there was no price either. You could argue that by reducing the price to 90 there would be buyers, but once again that needed to be proven.
This is where the "honor among thieves" broke down. Investment banks all hold billions of such complex financial products, for which there is no obvious source of demand left. Most of the other US brokers like Bear Stearns, Lehman Brothers, Goldman Sachs etc, when announcing their results last month for the June-August quarter (different investment banks have different financial year end), assumed certain values for these unsold securities.
Barely a month later, other banks, including the investment banking arms of various US commercial banks, reported earnings that were markedly lower. The worst of these was unarguably Merrill Lynch, whose results on Wednesday showed a dramatic reduction in the prices of various securities - in some cases, investments that had been priced at about 90 at the end of August were reduced to 30 or 40 at the end of September.
Extrapolating from this, it is clear that the investment banks which reported previously may well have more losses on their books. In that case, their stock market values will fall more dramatically in coming weeks as investors get used both to the losses and more importantly, the lies. The banks could certainly claim that their own models are correct while those of the banks posting losses this month were wrong, but given the cross-pollination of people that I talked about previously, this looks vastly unlikely.
There is a silver lining to all this though, at least for Americans. This week, Bear Stearns and China's CITIC Securities announced that they had exchanged a US$1 billion stake in each other to foment greater business cooperation. That announcement goes back to the point in my earlier articles that Asia will be called on to bail out the US financial system. Just like finding a buyer for a bear, a buyer for the bull will be found. The circus will continue, but the applause increasingly looks forced and sounds false. There are people out there whose pants are on fire, but who has the courage to start singing "Liar, liar"?
Why did the water suddenly get warmer in the "deep ends" of the public pool?!! Don't blame me just because I live in King County. I swear I was in the shallow end the entire time!
(The story was posted previously, but the potty humor puns pulled me in like a fly to a well, you know.)
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
Ummm, you might want to measure the viscosity as well as the temp in the deep-end of the public pool. Solid waste, y'know. I see a viscous cycle coming...
I live in the Midwest and saw a hundred-year flood twice in a six year period.
Sam Insull | 10.27.07 - 7:04 pm | #
The calculated probabilities regarding "100 year floods" are only as good as the assumptions about the underlying statistics. It seems the underlying statistics are changing.
I suggest that most of these forecasters do not appreciate the significance of nonstationarity.
A recent hedge fund study suggests marks are fraudulent and we ignore the information.
The Treasury secretary endorses the M-LEC to potentially prop up market prices and ignore the true marks of securities.
IB's and banks clearly have not realized all mark-to-market pricing of securities in the latest round of releases with more to come.
We are currently in a system which compliments fraud and a lack of true market pricing with full and fair disclosure. This is truly sad that the American public and the investor population allows this to take place or worse, purposefully ignores the reality & graveness of the situation in self-interest.
"To some extent therefore the price of complex derivatives can be compared to what happens in any fish market."
I like the analogy! Makes me think of Buffett and some well dressed banker meeting in some ungly commercial fishmarket.
Buffett asks, "So, what ya got in the bucket?"
IBanker: "Fish, I got some of the very best AAA-grade 'CDO'-fish the market has ever seen."
Buffett: "Oh, that sounds great. Let me take a look?"
IBanker: "No, I'm sorry to say you can't look into this bucket. We've got a number of confidentiality agreements and, well, frankly this bucket is a bit too complicated for someone of your -- background -- to understand. But, let me assure you that these are the finest CDO-fish on the market and this complicated bucket insures that its fish are always fresh."
Buffett: "Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in."
By the beginning of this year, Mr. Larson was worried about many kinds of riskier debt investments...to protect himself and take advantage of those risks, he bought senior debt securities and sold short..investments generally viewed as more risky...he borrowed as much as six times the firm's capital to generate respectable returns when his bets were right...but Mr. Larson's tactics started to backfire in June, when Sowood's investments lost 5%. Despite that, Sowood was up 5% during the first six months of the year, the fund managed more than $3 billion, and Mr. Larson stuck with his strategy...In early July, Mr. Larson put $5.7 million of his own money into the fund. And he directed his traders to borrow even more money...some large banks dealing with their own losses, sold investments that Sowood owned that were safer, and thus easier to trade...the riskier debt investments Sowood hoped would drop didn't move much...Mr. Larson called Ken Griffin, the head of Chicago hedge fund Citadel Investments, asking if he would be interested in buying Sowood's entire portfolio... On this point, few would dispute: Citadel has made big gains on the investments, according to people familiar with the situation.
Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in.
I'm tiring of these phrases like "Dark Matter" - I've taken progressively harder looks at this structured finance stuff - the latest was looking at the "rumble in the jungle" over the bankruptcy of Hollywood Video/Movie Gallery and its fallout in LCDS http://www.creditfixings.com/information2/movie_gallery_fixings_final_results.pdf
This isn't physics - physics is much more natural and "real" that this crap - this stuff is almost arithmetic with stochastic overlays - the freakin' mindblowin' intertwining is hard, I admit that but its only algorithms. I want to get concrete with this; the jargon and the intertwining complexity makes unravelling this hard but very doable - surely people in the know can just put the algorithms out in the public domain and we can all do simulations - and watch this MANMADE stuff as it unfolds, even predict it sometimes, without resorting to semi-magical thinking.
I've got a fair amount of idle CPU capacity that I'm ok with sharing, if anybody has got the algorithms.
Luminent is suing HSBC over margin calls made during the credit freeze in July. I guess HSBC seized the securities and then bought them at 50 cents on the dollar. They refused to return the securities even when LUM offered to buy them at par.
In a frozen market, margin agreements become a license to steal. I'm guessing we're going to see more than a few of these cases.
gasoline prices are finally beginning to move up. they are now at $2.86 average just where they were last july 31st when they began to go down. if they keep going up, i would expect a clear move into recession by year's end.
Beginning to see ads on TV about how to get training to do foreclosures. (I guess you need to pay and take a course to know how???). And other ads for "own a house without paying anything". I didn't get a good look at the fine print on that last. I imagine they prefer you not see it. LOL.
AIG is not going bankrupt. If it did... Well, talk about the ultimate "counterparty risk"!
Insurance companies often have low P/E ratios because they have the "lumpiest" earnings of any industry. (They make money in good years and lose money in bad years, so a low trailing-twelve-month P/E just means the previous year was good.)
Price/Book is the more common first-order metric for insurance companies. AIG's P/B is 1.53, which is low but not "oh my God" low. MTG, on the other hand, has a P/B of 0.36... And RDN clocks in at 0.19, which is incredibly low for a going concern, and way (WAY) below any sane valuation based on the company's guidance, which they reiterated this week.
Laugh all you want, but a lot of bad news is, in fact, discounted into these stock prices.
Actually, the short MTG + long RDN pair trade looks very interesting...
The calculated probabilities regarding "100 year floods" are only as good as the assumptions about the underlying statistics.
and the odds of rolling a 12 at the tables is 35-1...
that's does'nt mean you won't get three twelves in a row, or one in 105 rolls...
but over say, 15000 years... then , yeah , it's a 100 year flood avg.
that's what there SELLING the buyer, which sounds good, and they get there mark-up off of that.
just like the casino pays out only 30-1 on true 35-1 odds...
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
TanMan
sir, please put down the matches, and out the Cap Back On the Gas Can....
NOWWWWWWW
Buffett: "Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in."
Or rather,
Buffet: Son, nice try, but you already know that I am vegetarian.
When is Tanta writing her criticism of the article? I do not know what it is, but she rarely criticized Countrywide's lies (such as the ones made in yesterday's conference call) as passionately as she likes to criticize GM's articles.
and the odds of rolling a 12 at the tables is 35-1...that's does'nt mean you won't get three twelves in a row, or one in 105 rolls...but over say, 15000 years... then , yeah , it's a 100 year flood avg.
I'm not a quant jock but it always semmed to me that if you really walk a tightrope, at some point, it isn't an if but a when, an unexpected breeze will come up and you'll do a Karl Wallenda. He lasted 60 years but a breeze got him. Same in finance. If you leave yourself no margin for error, no willingness to accept that the predictable is NEVER completely so, at some point the unpredictable will get you. It isn't an if, but a when. Old news I guess.
I've got a fair amount of idle CPU capacity that I'm ok with sharing, if anybody has got the algorithms.
-K
sk | Homepage | 10.27.07 - 8:52 pm | #
They write books! Justin London has Modeling Derivatives Applications in Matlab, C++, and Excel
and Financial Instrument Pricing Using C++ by Daniel J. Duffy. Both available via Amazon. Of course, these are practical app books. You can also find pure mathemeatical financial algorithm text books.
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
TanMan
sir, please put down the matches, and out the Cap Back On the Gas Can....
NOWWWWWWW
GoreParadox | 10.27.07 - 9:18 pm | #
Thanks for the fun, some great lines here. It's to bad it's really going to happen as most at this site and rgemonitor have been saying for 18 months or so.
jo6pac.
Thanks
===============================
They write books! Justin London has Modeling Derivatives Applications in Matlab, C++, and Excel
and Financial Instrument Pricing Using C++ by Daniel J. Duffy. Both available via Amazon. Of course, these are practical app books. You can also find pure mathemeatical financial algorithm text books.
Napolean
Hey thanks. I usually go to Wilmott | Serving The Quantitative Finance Community | Home to make head or tail of this and that's the sort of down and dirty stuff I suppose I'm looking at and for.. a just-do-it approach - yup I've got Matlab, I've got... - but it would seem like I was getting into nerdy swinging dick crap. ( Do nerds even HAVE dicks ?)
I don't think Americans understand quite how vulnerable they have allowed themselves to become. The capital inflows have been so large for so long that what to the rest of us looks like a problem does not seem to to matter to them. That is understandable. If money keeps coming in, why should it suddenly stop? Well, there has been a good example in recent weeks of just such a change in sentiment in the gumming-up of the money markets. Northern Rock relied on the premise that it could keep borrowing from the markets to maintain faster growth than would be possible if it had to get most of its money over the counter at its branches. I am not saying the US is in a Northern Rock situation yet; just that markets are fickle creatures and I don't think the US financial model borrow 6 per cent of your GDP from the rest of the world each year is any more sustainable than the Northern Rock one.
So what will happen? On the balance of probability, the dollar will be pretty weak for the next three years, maybe longer. And there is a chance, which I would put at evens, of a sharp further decline in the coming months. If that were to happen, there would be a string of consequences. The headline price of oil, and other commodities denominated in the dollar, would shoot up. Many of the countries that still keep a dollar peg, such as those in the Gulf, would move the peg to a basket of currencies Kuwait has already done so. Central bank reserves would be further diversified, particularly into euros. Indeed, the dollar would stop being a special currency, losing much of its international role.
Maybe we won't quite reach that point. But if we do, well, it would be a shock for which the United States would be completely unprepared.
I think the unauthorized discussions Merrill's CEO made could have some serious ramifications for all the players with their hand in the sketchy ABS cookie jar.
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
Nemo says, "Insurance companies often have low P/E ratios because they have the "lumpiest" earnings of any industry."
You seem to imply that they don't do as well as the market, so they have low PE ratios. But the Yahoo chart indicates that several do quite a bit better than the market. I don't see the connection.
I see, possible bankruptcy is already priced in? LOL.
At 20% of book value, something approaching an 80% chance of bankruptcy is priced in. (Yes, yes, there are massive caveats to that statement... But it is close enough.)
So yes, "possible" bankruptcy is certainly priced in. Not for AIG... But for MTG and RDN? Absolutely.
Where did I imply insurance stocks don't do as well as the market? Almost by definition, on average they do exactly as well as the market...
Insurance companies normally make good money. But once in a blue moon, when the big hurricane or earthquake or whatever hits their clients, they have to pay out big time. This is what I mean by "lumpy" earnings.
So in normal years, the market gives them a P/E ratio below the market average. In big payout years, the market gives them a P/E ratio (way) above the market average. That's because the stock price, in general, is anticipating future earnings over the long run, not just looking at the earnings for the past year.
The trailing twelve month P/E tells you nothing about whether an insurance company is "cheap" or "expensive". You have to know what they insure (and where), so you can find out whether they had a "normal" year or a "big pay out" year, before you can even begin to see any meaning in that P/E.
The P/E is misleading for any cyclical company. It is literally worthless for evaluating insurance companies.
Never in Union Pacific's 145-year history have there been as many opportunities for employment and rapid advancement as there are today. With baby boomers retiring in record numbers and the intense demand for our transportation services, we're hiring in unprecedented numbers in every part of our company.
We need good people. And we need them now.
mortgage pro's... there's always jobs...
Will they take them? It's was a once very proud job... in the 1860-1910 period...
-KI was sifting through some of the other books on structured finance and thought this comment from 2004 was insightfull: But what I found most valuable was the focus on reduction-in-yield as the benchmark metric for ABS credit quality. Rather than credit ratings being an ex ante, handed-down-from-on-high, assumed-to-be-valid-within-a-notch-or-two inputs (which, I blush to admit, is how I too often think of them), the book points out how credit ratings should be thought of as a continuous, dynamic variable, interacting with the coupon, yield, prepayment vector, default vector, and triggers. The interactions are determined by cash flow modeling and Monte Carlo simulations, using the techniques mentioned above.
Given this framework and tools, the book discusses how to efficiently optimize the structured security. I have had ABS issuers ask if there were not a way to optimize securitizations beyond what they suspiciously perceived as Wall Street cookie cutter structures. Previously, I have just shrugged. Now I know how to help them. http://www.amazon.com/review/R2BF60EW3IPPMN/ref=cm_cr_rdp_perm/
I think you just need to pick a model you feel comfortable with. Use it as a crutch and convince other people of just how solid it is. Then hobble along for as long as you can until someone or something kicks that support out from under you.
Nemo, I haven't followed the insurance companies, but what you say makes sense. If I understand your "lumpy" earnings theme correctly, when you observe the earnings of the typical insurance company over time, the variance is very large relative to the mean. And if the market really does equate variance with risk, then the P/E ratio should be low at most times.
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
I believe that you grossly underestimate the labor required to calculate all of the cashflows a CDO is entitled to every month.
With some simplifying assumptions & rounding: Lets assume we have a $1.5b CDO that is half subprime mortgages and half student loans. Average loan amount in subprime is around $175,000, avg. student loan amount is $20,000.
Subprime securitizations from 04-06 averaged about $1b apiece (5,714 loans per deal in our example). Student loan deals are $500m (25,000 loans)
The CDO purchases AAA bonds from 30 distinct subprime securitizations & 6 student loan securitizations.
Now lets figure how many loans we have to run to figure out what cashflows the CDO gets to collect every month:
How many deals do we have to run every month to get the underlying cash flows: 36
Why do we have to run the underlying deals? Because they each have their own cascading waterfall of principal & interest payment rules for each of the individual bonds in the deal.
So how many loans do we have to keep track of to pass through the principal & interest on in the underlying deals? 30 deals5,714 loans + 6 deals25,000 = 321,420 loans. We need to know the new unpaid balance is for each loan every month, the new coupon if the rate has changed, and the amount of gross losses & excess borrower coupon interest every month to build the overcollateralization or subordination in each of the 36 deals. Each deal has unique stepdown credit enhancement triggers that are assessed each month to see whether we build up credit enhancement or not.
When I get all of those 321,420 unique cashflows every month, then I can determine how the bonds get passed through the CDO bonds. Each of the underlying 321,420 cashflows are passed through CDOs principal & interest cascade to determine the payment owed on each of the CDOs bonds. At this 2nd level of securitization, we have to again calculate the amount of principal shortfall (gross losses) & excess/shortfall of coupon interest every month to determine the amount of overcollateralization & subordination.
HERE IS THE MONEY SHOT: So 321,420 loans per month, 37 deal structures, credit enhancements & triggers. We have to calculate all of these EVEN IF WE ONLY WANT TO ANALYZE ONE BOND IN THE CDO.
If I am a fixed income manager, and I have, say, 2 dozen CDO positions, multiply all of the numbers above by 24 if you want to model all of these on your own. This is why the rating agencies are so integral to the process. The complexity is mind-numbing for anyone trying to value a deal, rerate a bond, or restructure the mortgage of one of the homeowners.
This is why the rating agencies are so integral to the process. The complexity is mind-numbing for anyone trying to value a deal, rerate a bond, or restructure the mortgage of one of the homeowners.
Gahhh.
If your institutions' software is inferior to that of the RA, then you shouldn't be buying these sorts of securities at all. If your people can't do the work the RA's can do? You need better people. Relying on the RA's is a wonderful way to underperform (best case) or go broke.
I believe that you grossly underestimate the labor required to calculate all of the cashflows a CDO is entitled to every month.
I'm certain you are right about my estimation capabilities - and the example you've quoted is great in helping me scope the size of the problem. From a computing perspective, my rough calculation was around 30 million entity occurrences/month in the example - quite doable. The data model - loans, deal structures, CDOs, managers - seems straightforward. There are several computing hard aspects involved here but that's my biz so those I can handle.
I handle, just-cos-I'm-interested, 3 hourly weather forecasts at hourly intervals, 3 days forward, at 1.4 Km grid intervals across the entire Los Angeles basin, 7 days/week, 9 hours/week, ALL automated as part of my just-cos-I'm-interested pollution model. Modern computing tools really are very very good.
But of course, who's going to give me monthly cash flow data ? The government is very charitable with weather data so that was easy. Its not as simple as knocking on farm doors 600 miles away asking to buy GREEN peanuts ( just-cos-I-like-them) I expect but if I could solve that, I can have a heck of a bash at making progress on this.
Thanks again for the example. I'll work on it more.
sk, no point in working on the math now. Is that guy in Arizona done with those political simulations? Maybe your CPU-time would be better spent attempting to calculate time-until-pitchfork.
"If there's one thing we know about the mortgage crisis, it's that it keeps turning policymakers and bankers into liars.
In June, Treasury Secretary Henry M. Paulson Jr. said mortgage problems "will not affect the economy overall." Merrill Lynch boss E. Stanley O'Neal said the mortgage mess was "reasonably well contained" the same month."
So, the investors didn't understand that the ratings agencies wouldn't understand that banks couldn't understand that the homeowners wouldn't understand loans that no one could understand.
Cue theme from 'The Sting,' as the handful of guys who understood laugh heartily in a warehouse full of cash.
I dont believe (opinion here) many CDO investors playing in the AAA space modeled the AAA pieces of CDOs they purchased.
They relied on the rating agency stamp of approval at origination of the CDO. There is a much-higher likelihood that BBB buyers did their own modeling since they were taking on more risk.
The rating agencies were, and still are, an integral part of that process, busted as it is.
The Street creates complex securities, and investors looking for yield dont do what we consider prudent due diligence: they didnt model & stress the cashflows.
CDO cashflows are simply too complex for the average institutional investor to model.
Clyde: The CDO purchases AAA bonds from 30 distinct subprime securitizations & 6 student loan securitizations.
I think you have that wrong. AAA bonds didn't need to be packaged into CDOs, they had a market. The reason for creating CDOs as a means of getting higher rated securities from lower rated ones. Correct?
I believe, the subprime bonds packaged into CDOs were usually BBB and lower. That way, at least some part of them, could magically become AAA and AA CDO bonds.
Clyde: CDO cashflows are simply too complex for the average institutional investor to model.
I think the point being argued is, if that's the case, the institutional investors shouldn't be buying CDOs. Isn't that obvious?
Well, the biggest problem is building or renting & maintaining the cash flow "engine". The institutions that do model use Intex, Wall Street Analytics (although Moodys bought them so I don't know what they are called now) and there is a little cottage industry of consultants with proprietary engines. Some of the accounting firms still use spreadsheets, but they must be massive. You need the engine to run each of the loans every month (300k plus in our example, all of the numbers below will be from the problem posited in my prior post) comparing the cash received from the borrower to scheduled amortization called for in the mortgage note.
But even if you buy the engine, the crunching task is daunting.
The cashflows for each mortgage have to be run every month FROM INCEPTION; it is very difficult to start at month 6 or 12 because you need to have accurately modeled the overcollateralization & subordination & triggers every single month to know what the OC/sub/triggers are for each succeeding month.
The engine also has to be able to accommodate all of the math functionality needed to model the principal & interest payment rule cascades in the underlying 36 deals and the CDO itself. Very tricky, especially for a non-financial modeler.
To figure those out, you will have to read 37 prospectuses & purchasing & sales agreements (PSAs) and all of the side letters (hiding fees that should be in the prospectus). That is about 300-400 pages of documentation per deal, so 37x350 pages = 12,950 pages you will have to read word-for-word to accurately model the waterfalls.
All of the cashflows on the underlying deals have to be tied out to the bond payments & the OC/sub/trigger buckets, penny for penny. Then you would have to figure out a way to funnel the cash flows from the bonds you own on the underlying 36 deals SIMULTANEOUSLY to your CDO structure, once a month.
You pass the aggregate tied-out cashflows through the CDOs own principal & interest waterfall, which determines the principal & interest amounts passed to each of the CDO bonds. Then calculate & store the levels of the OC/sub/triggers for the CDO structure.
Every month. From inception. Even if you only own 1 bond in the CDO.
Clyde,
Isn't there also a fundamental problem that the risk assumptions that go into the mortgage instrument part of a CDO are unknowable?
I certainly have seen my share of clients who take incorrect transactional data, then spend lots of time analyzing it and producing published financial statements.
of course deck sweeping is SOP...but, as it's been discussed many times on this blog, it becomes a big deal when the arcane shit actually trades and marks other players to market, not to model.
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
Scenario #1: the people who put the current CEO in place say "We made a fundamental mistake and need to change our direction completely."
Scenario #2: "We had the right basic idea, it's just that the current guy is corrupt and/or inept. Just get a better version of the same model and everything will be fine."
To figure those out, you will have to read 37 prospectuses & purchasing & sales agreements (PSAs) and all of the side letters (hiding fees that should be in the prospectus). That is about 300-400 pages of documentation per deal, so 37x350 pages = 12,950 pages you will have to read word-for-word to accurately model the waterfalls.
All of the cashflows on the underlying deals have to be tied out to the bond payments & the OC/sub/trigger buckets, penny for penny. Then you would have to figure out a way to funnel the cash flows from the bonds you own on the underlying 36 deals SIMULTANEOUSLY to your CDO structure, once a month.
You pass the aggregate tied-out cashflows through the CDOs own principal & interest waterfall, which determines the principal & interest amounts passed to each of the CDO bonds. Then calculate & store the levels of the OC/sub/triggers for the CDO structure.
You bet. My, kinda rude but just to make the point thinking, around this is that the guys who wrote the prospectus were technical authors who worked through the computer programs/algorithms and just documented them - meaning that at source we had computing implementations of the schemes, SOMEWHERE. I'd asking for these schemes to be put in the public domain - that would of course make the task easier
Otherwise, it will have to be re-engineered. And, in my experience, its doable, but vastly speeded up as a result of help from insiders. ( An older experience of mine, from 199x/200x, is the way a group of people "decoded" and disseminated the workarounds for the region code lock on the APEX DVD player. Man, that region code pissed off people - it had shades of 1984 - dividing the world into Oceana, Eurasia, Eastasia - in it- thankfully, now, the unlocking mechanisms for so many DVD players are so widely distributed the whole edifice is worthless).
The calculation difficulty and the fact that raters got caught by that 'hundred year event' means that rating will cost more in the future. This whole thing has a long, long way to go before it is played out. At this point it is like the Tech stocks just at the end of their high flying days. When it is all through there will be structural changes in the mortgage business, in the rating business, in the investment banking business and possibly in some international relationships.
Dont shoot the messenger, just illustrating a complex system for our resident weatherman who wants to show his stuff. Whether CDO investors are negligent is another thread.
Banker hearts anyone for saying the rating agencies are an integral part of the process, but I say that precisely because most investors dont model AAA CDO bonds.
Big leaguers like him dont like sharing a locker room with high school talent (yes, the gap is that wide). But it is what it is: they literally line up against each other on each securitization (hundreds every month if you include all the asset classes, thousands every year).
The data I have on the AAA/BBB split for subprime paper in CDOs is at the office, I will produce it tomorrow. If memory serves, over 50% of CDOs are fed by mortgage cashflows, so subprime is a fraction of that mortgage slice.
Regarding your link above about the Seattle investment pool... It inadvertantly highlights a huge problem going forward for the CP market- that many of the investors are restricted in what they can buy. Thus, CP performance issues may cause a cascade effect which will further worsen future CP market performance...
From the article:
"But the turmoil in the U.S. mortgage markets has eroded the portfolio value of many SIVs, hampering their ability to redeem their commercial paper on time or refinance by issuing new paper." [snip]
"The pool is a sort of piggy bank where local governments can stash their excess cash until it's needed; by law, earning high returns takes a back seat to safety. As recently as two months ago, the pool had about $1 billion, or nearly 25 percent of its assets the statutory maximum invested in commercial paper."
"But after the investment rating of another commercial-paper fund in the pool's portfolio, Mainsail II, was cut to junk, the pool stopped buying new commercial paper."
Clyde is right. The problem with CDOs composed of tranches and hunks of other tranched/chunked pools of debt is that you have to model the performance of every one of the underlying pools to get the expected performance and valuation of your payment rights to that pool, then plug in all expectations of the individual pieces of the CDO to model its entire performance. Once you have done that, you can figure the valuation of your own chunk of the CDO.
This business really ran only on trust and confidence. These debt instruments are inscrutable.
Another problem is that the real performance of many of the underlying pools were not originally stress-tested, and it is hard to get the data to do so. For certain types of debt, there are failure correlations, so those should be included in the calculations.
Here is where a CR reader should reflect back to Tanta's comments about the Fitch assumptions and the problem with low/no doc or stated loans. If you don't know factors such as true starting DTI and occupancy, your evaluations of the underlying pools are sure to be highly problematic. Area risk is now a dominating factor for even prime loans, so you have to include that. Thornburg was hit by area risk.
Pools that were dominated by loans with prepayment charges and early ARM resets are now showing a slow rate of prepayment, which reduces the estimated payoffs for some of the tranches immensely.
The real assumptions backing a lot of the pool expectations and ratings were that housing would continue to appreciate into the foreseeable future, even if that appreciation slowed down to a nominal 5% or so, and that credit terms would continue to be as easy as they were at origination.
The calculation difficulty and the fact that raters got caught by that 'hundred year event' means that rating will cost more in the future
yeah off course, i have a better proposal, outsource it to the bangalore street, it will be cheaper and have the same effect
IF you saw your name(oneal) in ill-reput spread across the nations rags, because you were playing the same game as all your competitors, what would you do on your last week in office?
MOM, That's what I don't understand. Someone can design a very slick valuation model, but that means nothing if there's no integrity to the underlying data (including assumptions).
A CFO where I worked would berate people who didn't have firm foundations for budgetary numbers by telling them "so, why don't we just pick a number from the phone book!".
If all the mortgages in the 30 deals were prime mortgages and all the student loans in those 6 deals were to Ivy Leaguers, then the risks would be somewhat knowable.
Unlike market value problems in the SIVs, the risks in CDOs backed by mortgages are really at the borrower level. Not sure if there are SIVs in CDOs since I am a mortgage guy.
That is why Tanta's analysis on the ground from the battlefield is so striking: the biggest risk right now is severity of loss. A lot of these credit enhancements were sized with severities of 30-40% in mind (fhe old hands used 45-50%). But now we are getting severities north of that because of the bank/servicer inability to sell foreclosures at a market clearing price. When they finally throw in the towel, the carrying costs & servicing charges alone will put them over 50% (most of the defaulted mortgage payment is usually interest). Then there is the geographic death-spiral effect in places like the Inland Empire.
Think of the investor problem in terms of number of bonds owned. If you have 50 or 60 positions, you probably have 12-15 servicers working on your severity problems. If you diversified your holdings by asset class and geography and bought paper that was going to be serviced by a top quartile servicer, you can have a tighter dispersion on your guess for future severities, & thus future bond losses.
If you were not that diversified, the severity dispersion would be much wider. And if you did not control for credit by buying from servicers in the top quartile, your severities are going compound exponentially.
If you are an investor in the 2nd group, your risks are clearly not linear.
It seems like the toughest part to the modeling issue is the initial data entry. Obviously all these parameters, as many as they may be, surrounding all the various loans making up the security can be modelled with computers. So, if you have the proper software, all one needs to do is feed it the info.
Even without the lack of documentation in recent mortgages, it seems to me data entry would be the most likely source of error.
In regards to the CDO insurers, would they blindly accept the ratings of the underlying pools of mortgages or would they create their own and run their own loss models?
This business really ran only on trust and confidence. These debt instruments are inscrutable."
Nonsense. Why does AIG, for example, have over 100 fixed income analysts? What do you think the job of a number of those folks is???????
The idea that the RA are the paradigm of excellence and that the insitutions who bought this stuff are unable to apply the resources to figure this stuff out is laughable.
If the RA were viewed by the buyside as the arbiters, why do variuous AAA securities trade at disparate spreads? Because the market recognizes that the RA's are insufficiently granular in their analysis. If the RA's were relied upon the way some here claim, all commonly rated bonds of a given maturity and duration would trade withing a few basis points of each other. It doesn't remotely work that way.
Banker - Why does AIG, for example, have over 100 fixed income analysts? What do you think the job of a number of those folks is???????
The insurance guys are taking and are going to take some severe losses of their own, thus proving that their analysis was faulty. MBIA, Ambac - they're all sitting in the hot seat now.
Obviously, they can't analyze effectively under these circumstances. Why is MBIA's SIV in such deep trouble? Their reported losses and anticipated losses make your argument something of a sick joke for anyone who owns stock in these companies.
And I know why they can't. They can't because of lack of underwriting control, which rendered all analysis an exercise in wishful thinking and blind trust.
Please understand what I am saying. I am not saying that these analysts connived in this. They had nothing to gain. I am not saying that they are stupid. Many of them have years of experience and highly successful track records. But they did operate in an environment which assumed that what was reported about loans was true, and that environment no longer exists.
Nobody can BS me on this. I know what needs to be done to implement controls at the institution and portfolio level, and one way or another, the same controls need to be available in longer chains of underwriting - and they haven't been since 2005. The appraisals were often crap and the DTIs are often effectively unknown or unverified. See Lama's comment.
I'm not going to mention any names, but I can tell you right now that the DTIs still being written at a bunch of the big boys are unstable. We have a long, long way to go in this credit correction. Things are going to get worse and not better, and part of the reason is that other forms of collateralized debt are getting in trouble as we speak. Those car loans and CC debt have lost their luster.
Nobody seems to register the real meaning of American Express commenting that revenues net of interest expense (which was higher) rose 12% in the third quarter for its US Card group. They say they got that on higher borrowing by consumers and small businesses. Well you don't see that in the stores, do you? A huge chunk of that went to pay bills and possibly other debt.
The correlations are moving higher every month, and that means the well is poisoned.
No one on this thread said the rating agencies were excellent. You are on a jihad against them, and we don't know why.
I think most of us agree there is a wide gap in talent. Did one of them steal your girl friend or something?
Most of the hypotheticals we collectively have been speaking about are the challenges faced by the average institutional investor, not the AIGs of the world. And rating agencies continue to be on every deal, are they not?
This rating agency hangup of yours is the only blind spot that I have seen of yours. It is surprising. I am at a loss.
Banker asks: Why does AIG, for example, have over 100 fixed income analysts?
In the hopes of getting two to agree?
Really funny!
Thanks to everyone who has contributed in todays comments.
My little contribution is ...
1) link to a September presentation by S&P that gives some statistics on CDOs and the contents thereof... http://www2.standardandpoors.com/spf/pdf/media/subprime_revised_sp_asf_19sep07.pdf
Notice that even the high grade CDOs have about 10% in mezanine CDOs (very likely to default IMHO) - see pages 8 & 9.
CR, your blog is great!
Someone is suggesting that the Emperor's wardrobe may not be as complete as once thought. This line of thought might catch on one day.
Hi
I love coming by here it always makes me feel better. I won't feel bad for any of them when they start jumping out the windows. I just wonder how many of them know the glass is thick and it doesn't open, I guess we'll find out by hospital numbers of those injured when they bounce back. Sure hope the medical is paid up. Oh well back outside to get next years garden area ready.
jo6pac
LTS,what's wrong with a couple of transparent pasties and a G string?
Discounted, the new Contained.
But will discounts be in the next container?
Christmas season is approaching and I need to know how much longer China can follow our currency down!
I agree that things are a whole lot worse than anyone is letting on. This should be a huge opportunity to load on the shorts but the problem is that until it matters it doesn't, and in the meantime you get killed. Its also not fun always being the party pooper. I'm thinking about just drinking the kool-aid and partying 'cause it just never seems to end.
Please someone tell me how I can benefit (er, profit) from this information (to which I agree with the interpretation almost always)? Although I am specifically referring to this particular blog entry, I really want to understand the potential benefit from the overall content on this site.
Should I be buying something now? Should I be selling something now?
Should I be saving my money to buy at some point in the future [and will we recognize this moment when it is upon us]?
Thanks...I just love this blog.
Any AAA, AA, A or whatever rating that's based on insurance may not be worth the paper it's written on.
Including Munis. Look, they aren't going to allow you to repossess a sewer system and run it to get your money back. California particularly is set to be repudiating any number of "insured" debt instruments. Shoe two to drop.
The junkie needs more fixes and stronger fixes to get the same bang. Totally addicted. Correct me if I am wrong.
A few thoughts.
I think things will get worse before they get better for structured credit products. That said, Bond Insurers tend to insure only the very safest tranches of ABS and MBS. These tranches may be getting written down at Merrill, but that doesn't mean they're going to default. Its only if they default that the Bond Insurers would be in any kind of trouble. That's possible I guess, but still seems pretty remote - and I'm usually the cynic.
The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon.
There's a comment in Barron's this week the MGIC guaranteed 27% of the debt in Alt-A mortgages. Need I say more?
Everything at the overnight rate...
one yield
one mark
MGIC guaranteed 27% of the debt in Alt-A mortgages
Guaranteed or insured...
I can't even figure out my CC contract...
can you imagine the verbage in a cdo/mbs stipuated guarantee
"There's a comment in Barron's this week the MGIC guaranteed 27% of the debt in Alt-A mortgages. Need I say more?"
MGIC are very different from bond insurers like MBIA or Ambac. MGIC provide private mortgage insurance. I'm not sure if you were responding to my post.
LTS,what's wrong with a couple of transparent pasties and a G string?
Tom Stone | 10.27.07 - 4:34 pm | #
Tom, if the pasties were truly transparent, that would be one thing. But they're so darned opaque.
As for the G-String... I'm not going there!
"I can't even figure out my CC contract...
can you imagine the verbage in a cdo/mbs stipulated guarantee"
That is what you have a bankruptcy attorney for.
Confined, discounted... what's next?
If the insurers fail what will be the new mantra coming fo the rescue?
Default? Heck, if it's marked down far enough the leveraged hit will be enough to do sufficient damage.
The one odd thing about the whole credit/housing melt-down is that the more the problems become acknowledged, the greater becomes the delusion about the consequences...
CR,
In case you're looking for a new bubble to follow in a year or so, I suggest alpacas!
They are basically being bred to sell as breeders. A female might fetch $10-20,000, a male with a good bloodline can command $100,000+.
But the only sustainable thing they can be raised for is their wool, but that would return about the cost of feed, shelter and medical care.
It's an incredible pyramid that will crash spectacularly. Imagine if condos in Miami actually reproduced, that's the alpaca market in a nutshell.
I wish there were a market in alpaca puts... Maybe there will be a new ETF..
Do you think that if AIG went bankrupt that might send the Dow down a bit, for a week or so? Or would it jump up, with a hysterical sigh of relief, as it did with MER?
The model for municipal bond insurance has always been that it will work in all environments except a hundred-year flood. So, even if the muni insurance companies didn't have all the mortgage and derivatives exposure (which is big), they would be vulnerable in a severe once-per-century credit crunch. Now, they are about to get hit on both sides at once.
The market has always believed governments can support GO bonds with their taxing power. But Orange County couldn't in the 90s because of a taxpayer revolt. There will be more revolts, but the biggest vulnerability is the massive amounts of industrial development bonds and revenue bonds that don't have taxing power. Many are insured. Defaults among IDBs and revenue bonds will be one of the biggest stories of 2008 and it will take down at least one muni bond insurer. As Fleck says, that will trigger downgrades in all bonds that carry the same insurance. (The insurance is permanent for the life of the bond.)
Scarfed this from Ben's blog. AutoNation says sales are tanking in bubble zones.
Herald Trib Article
We are running out of canaries.
Some P/E ratios for mortgage insurance companies:
PMI Mortgage.....4.34
MGIC.............n/a
Triad Guarantee..2.24
Radian...........2.39
If you think incredibly low P/Es are a bad sign, there they are.
I guy I know asked me about alpacas, I told him it was a cross between MLM and condos, and for what a female costs he could plant his TN acreage in heirloom fruit trees and have $5k left over and his maint. costs would be less than the $5000 by the time they started bearing fruit and paying for themselves. The farming gives him a tax break and his upfront money can be invested in laddered CDs.
He starts planting next month, has been talking to upscale restaurants to gauge future interest.
It ain't a grand slam, but it'll be a nice double, especially when the specuvestors behind his land(without water or sewer access) get blown out and he picks up their pieces.
MGIC Barron's comment
"But at this point, Radian looks like the better bet than MGIC. For one thing
Radian has two business lines rather than one. Moreover, MGIC's dollar-loss
per claim is going up faster than Radian's. That's because Radian shrewdly
capped its loss exposure on its Alt-A mortgages to just 14% of the unpaid
principal, while MGIC is paying out on over 27% of Alt-A mortgage losses.
What makes that category so lethal is the fact that the size of these
generally "no documentation" mortgages is so much larger than subprime
mortgages.
Conditions in the mortgage market won't improve for many quarters. But a
pair trade involving going long Radian and selling short MGIC might well
work out while panic reigns."
The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon.
Seems like a price that just caused me change my shorts
Seems like a price that just caused me change my shorts
Specify. On this forum that can have a double meaning.
Dryfly LOL! Took me a minute to figure it out, but then I laughed.
Doc Zoid, the ABX.HE indexes are for MBS, not CDOs. But the news about the AAA CDO downgrades probably hurt ABS. Btw, intraday got below 82 for AAA 07-1.
I figured that was an intentional pun.
Specify. On this forum that can have a double meaning.
Depends
Btw, intraday got below 82 for AAA 07-1.
Not again! I'm now convinced that I better plan on doing my laundry on a more frequent basis for the forseeable future.....
Discounted, the new Contained.
But will discounts be in the next container?
Christmas season is approaching and I need to know how much longer China can follow our currency down!
Stagflationary Mark | Homepage | 10.27.07 - 4:35 pm | #
I think it's pretty simple but that's just me a few others.
Think Summer Olympics, then BYE,BYE Dollar
jo6pac
Depends
That could be another pun, depending upon your age (and strength of your bladder).
The model for municipal bond insurance has always been that it will work in all environments except a hundred-year flood.
I live in the Midwest and saw a hundred-year flood twice in a six year period.
FT - Doubts emerge over guarantors' creditworthiness (MBIA & AMBAC)
"The perceived creditworthiness of two of the largest financial guarantors in the US on Thursday plunged to lows not seen since the worst of the credit squeeze in August."
FT.com / Capital Markets - Doubts emerge over guarantors’ creditworthiness
"The ABX for triple A CDS insurance posted by CR yesterday showed a steep drop, but its still trading at 87 cents on the dollar. That doesn't seem like a price that indicates default anytime soon."
--tis but a flesh wound, said the black knight ...
To some extent therefore the price of complex derivatives can be compared to what happens in any fish market. If for any reason no buyer shows up, prices of fresh fish fall dramatically as they have to be sold as either frozen food or worse, as fish feed. That leaves very little room for maneuver for the average fisherman.
The world of investment banking, by creating increasingly complex products, also went down this same path wherein demand for its products was the only real proof of prices ever available. In other words, the fact that an investor bought a security from you at say 100 meant that the value of the security was 100. If there was no investor, then by logical deduction there was no price either. You could argue that by reducing the price to 90 there would be buyers, but once again that needed to be proven.
This is where the "honor among thieves" broke down. Investment banks all hold billions of such complex financial products, for which there is no obvious source of demand left. Most of the other US brokers like Bear Stearns, Lehman Brothers, Goldman Sachs etc, when announcing their results last month for the June-August quarter (different investment banks have different financial year end), assumed certain values for these unsold securities.
Barely a month later, other banks, including the investment banking arms of various US commercial banks, reported earnings that were markedly lower. The worst of these was unarguably Merrill Lynch, whose results on Wednesday showed a dramatic reduction in the prices of various securities - in some cases, investments that had been priced at about 90 at the end of August were reduced to 30 or 40 at the end of September.
Extrapolating from this, it is clear that the investment banks which reported previously may well have more losses on their books. In that case, their stock market values will fall more dramatically in coming weeks as investors get used both to the losses and more importantly, the lies. The banks could certainly claim that their own models are correct while those of the banks posting losses this month were wrong, but given the cross-pollination of people that I talked about previously, this looks vastly unlikely.
There is a silver lining to all this though, at least for Americans. This week, Bear Stearns and China's CITIC Securities announced that they had exchanged a US$1 billion stake in each other to foment greater business cooperation. That announcement goes back to the point in my earlier articles that Asia will be called on to bail out the US financial system. Just like finding a buyer for a bear, a buyer for the bull will be found. The circus will continue, but the applause increasingly looks forced and sounds false. There are people out there whose pants are on fire, but who has the courage to start singing "Liar, liar"?
Asia Times Online :: Asian news and current affairs - Pants on fire
James, if AIG failed, the dow would rally, as 'all the bad news is out.'
Same as if a bomb decimated a large city, that would rally the Dow, as all the reconstruction would be good for the GDP.
That's the current mind set anyway. The only thing better than good news is bad news.
gretchen morgenson of nyt on subprime, and cdo's..
FAIR PLAY; Guesstimates Won't Cut It Anymore - NY Times
Depends
Why did the water suddenly get warmer in the "deep ends" of the public pool?!! Don't blame me just because I live in King County. I swear I was in the shallow end the entire time!
(The story was posted previously, but the potty humor puns pulled me in like a fly to a well, you know.)
Denial phase seems to have several sub phases.
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
Ummm, you might want to measure the viscosity as well as the temp in the deep-end of the public pool. Solid waste, y'know. I see a viscous cycle coming...
I live in the Midwest and saw a hundred-year flood twice in a six year period.
Sam Insull | 10.27.07 - 7:04 pm | #
The calculated probabilities regarding "100 year floods" are only as good as the assumptions about the underlying statistics. It seems the underlying statistics are changing.
I suggest that most of these forecasters do not appreciate the significance of nonstationarity.
We are setting an extremely dangerous precedent.
A recent hedge fund study suggests marks are fraudulent and we ignore the information.
The Treasury secretary endorses the M-LEC to potentially prop up market prices and ignore the true marks of securities.
IB's and banks clearly have not realized all mark-to-market pricing of securities in the latest round of releases with more to come.
We are currently in a system which compliments fraud and a lack of true market pricing with full and fair disclosure. This is truly sad that the American public and the investor population allows this to take place or worse, purposefully ignores the reality & graveness of the situation in self-interest.
"To some extent therefore the price of complex derivatives can be compared to what happens in any fish market."
I like the analogy! Makes me think of Buffett and some well dressed banker meeting in some ungly commercial fishmarket.
Buffett asks, "So, what ya got in the bucket?"
IBanker: "Fish, I got some of the very best AAA-grade 'CDO'-fish the market has ever seen."
Buffett: "Oh, that sounds great. Let me take a look?"
IBanker: "No, I'm sorry to say you can't look into this bucket. We've got a number of confidentiality agreements and, well, frankly this bucket is a bit too complicated for someone of your -- background -- to understand. But, let me assure you that these are the finest CDO-fish on the market and this complicated bucket insures that its fish are always fresh."
Buffett: "Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in."
Cautionary tail in today's WSJ:
By the beginning of this year, Mr. Larson was worried about many kinds of riskier debt investments...to protect himself and take advantage of those risks, he bought senior debt securities and sold short..investments generally viewed as more risky...he borrowed as much as six times the firm's capital to generate respectable returns when his bets were right...but Mr. Larson's tactics started to backfire in June, when Sowood's investments lost 5%. Despite that, Sowood was up 5% during the first six months of the year, the fund managed more than $3 billion, and Mr. Larson stuck with his strategy...In early July, Mr. Larson put $5.7 million of his own money into the fund. And he directed his traders to borrow even more money...some large banks dealing with their own losses, sold investments that Sowood owned that were safer, and thus easier to trade...the riskier debt investments Sowood hoped would drop didn't move much...Mr. Larson called Ken Griffin, the head of Chicago hedge fund Citadel Investments, asking if he would be interested in buying Sowood's entire portfolio... On this point, few would dispute: Citadel has made big gains on the investments, according to people familiar with the situation.
HVH,
I assure you it is a Baby Ruth!
Jack Staub,
Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in.
Not even a Honey Bucket?
(Shame on me!)
I'm tiring of these phrases like "Dark Matter" - I've taken progressively harder looks at this structured finance stuff - the latest was looking at the "rumble in the jungle" over the bankruptcy of Hollywood Video/Movie Gallery and its fallout in LCDS
http://www.creditfixings.com/information2/movie_gallery_fixings_final_results.pdf
This isn't physics - physics is much more natural and "real" that this crap - this stuff is almost arithmetic with stochastic overlays - the freakin' mindblowin' intertwining is hard, I admit that but its only algorithms. I want to get concrete with this; the jargon and the intertwining complexity makes unravelling this hard but very doable - surely people in the know can just put the algorithms out in the public domain and we can all do simulations - and watch this MANMADE stuff as it unfolds, even predict it sometimes, without resorting to semi-magical thinking.
I've got a fair amount of idle CPU capacity that I'm ok with sharing, if anybody has got the algorithms.
-K
Banker,
Luminent is suing HSBC over margin calls made during the credit freeze in July. I guess HSBC seized the securities and then bought them at 50 cents on the dollar. They refused to return the securities even when LUM offered to buy them at par.
In a frozen market, margin agreements become a license to steal. I'm guessing we're going to see more than a few of these cases.
gasoline prices are finally beginning to move up. they are now at $2.86 average just where they were last july 31st when they began to go down. if they keep going up, i would expect a clear move into recession by year's end.
Beginning to see ads on TV about how to get training to do foreclosures. (I guess you need to pay and take a course to know how???). And other ads for "own a house without paying anything". I didn't get a good look at the fine print on that last. I imagine they prefer you not see it. LOL.
AIG is not going bankrupt. If it did... Well, talk about the ultimate "counterparty risk"!
Insurance companies often have low P/E ratios because they have the "lumpiest" earnings of any industry. (They make money in good years and lose money in bad years, so a low trailing-twelve-month P/E just means the previous year was good.)
Price/Book is the more common first-order metric for insurance companies. AIG's P/B is 1.53, which is low but not "oh my God" low. MTG, on the other hand, has a P/B of 0.36... And RDN clocks in at 0.19, which is incredibly low for a going concern, and way (WAY) below any sane valuation based on the company's guidance, which they reiterated this week.
Laugh all you want, but a lot of bad news is, in fact, discounted into these stock prices.
Actually, the short MTG + long RDN pair trade looks very interesting...
The calculated probabilities regarding "100 year floods" are only as good as the assumptions about the underlying statistics.
and the odds of rolling a 12 at the tables is 35-1...
that's does'nt mean you won't get three twelves in a row, or one in 105 rolls...
but over say, 15000 years... then , yeah , it's a 100 year flood avg.
that's what there SELLING the buyer, which sounds good, and they get there mark-up off of that.
just like the casino pays out only 30-1 on true 35-1 odds...
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
TanMan
sir, please put down the matches, and out the Cap Back On the Gas Can....
NOWWWWWWW
Stagflationary Mark,
Thanks for sharing (the honey bucket)! You've got to love YouTube.
Buffett: "Son, when everyone for three blocks away can smell that you've got a bucket of old dead fish, it just doesn't matter what kind of bucket you put'em in."
Or rather,
Buffet: Son, nice try, but you already know that I am vegetarian.
gretchen morgenson of nyt on subprime, and cdo's..
- NY Times? ref=business
When is Tanta writing her criticism of the article? I do not know what it is, but she rarely criticized Countrywide's lies (such as the ones made in yesterday's conference call) as passionately as she likes to criticize GM's articles.
Must be some woman thing.
and the odds of rolling a 12 at the tables is 35-1...that's does'nt mean you won't get three twelves in a row, or one in 105 rolls...but over say, 15000 years... then , yeah , it's a 100 year flood avg.
I'm not a quant jock but it always semmed to me that if you really walk a tightrope, at some point, it isn't an if but a when, an unexpected breeze will come up and you'll do a Karl Wallenda. He lasted 60 years but a breeze got him. Same in finance. If you leave yourself no margin for error, no willingness to accept that the predictable is NEVER completely so, at some point the unpredictable will get you. It isn't an if, but a when. Old news I guess.
I've got a fair amount of idle CPU capacity that I'm ok with sharing, if anybody has got the algorithms.
-K
sk | Homepage | 10.27.07 - 8:52 pm | #
They write books! Justin London has Modeling Derivatives Applications in Matlab, C++, and Excel
and Financial Instrument Pricing Using C++ by Daniel J. Duffy. Both available via Amazon. Of course, these are practical app books. You can also find pure mathemeatical financial algorithm text books.
Dudes! What are you worried about? Didn't you hear Countrywide on Friday? Housing has bottomed. Everything has been written down and a return to profitability is just around the corner. Take a chill pill.
TanMan
sir, please put down the matches, and out the Cap Back On the Gas Can....
NOWWWWWWW
GoreParadox | 10.27.07 - 9:18 pm | #
Thanks for the fun, some great lines here. It's to bad it's really going to happen as most at this site and rgemonitor have been saying for 18 months or so.
jo6pac.
Thanks
Sam Insull | 10.27.07 - 7:04 pm | #
Haven't I heard that name before?
===============================
They write books! Justin London has Modeling Derivatives Applications in Matlab, C++, and Excel
and Financial Instrument Pricing Using C++ by Daniel J. Duffy. Both available via Amazon. Of course, these are practical app books. You can also find pure mathemeatical financial algorithm text books.
Napolean
Hey thanks. I usually go to Wilmott | Serving The Quantitative Finance Community | Home
to make head or tail of this and that's the sort of down and dirty stuff I suppose I'm looking at and for.. a just-do-it approach - yup I've got Matlab, I've got... - but it would seem like I was getting into nerdy swinging dick crap. ( Do nerds even HAVE dicks 
?)
In addition to that, any other ideas, anybody ?
-K
I don't think Americans understand quite how vulnerable they have allowed themselves to become. The capital inflows have been so large for so long that what to the rest of us looks like a problem does not seem to to matter to them. That is understandable. If money keeps coming in, why should it suddenly stop? Well, there has been a good example in recent weeks of just such a change in sentiment in the gumming-up of the money markets. Northern Rock relied on the premise that it could keep borrowing from the markets to maintain faster growth than would be possible if it had to get most of its money over the counter at its branches. I am not saying the US is in a Northern Rock situation yet; just that markets are fickle creatures and I don't think the US financial model borrow 6 per cent of your GDP from the rest of the world each year is any more sustainable than the Northern Rock one.
So what will happen? On the balance of probability, the dollar will be pretty weak for the next three years, maybe longer. And there is a chance, which I would put at evens, of a sharp further decline in the coming months. If that were to happen, there would be a string of consequences. The headline price of oil, and other commodities denominated in the dollar, would shoot up. Many of the countries that still keep a dollar peg, such as those in the Gulf, would move the peg to a basket of currencies Kuwait has already done so. Central bank reserves would be further diversified, particularly into euros. Indeed, the dollar would stop being a special currency, losing much of its international role.
Maybe we won't quite reach that point. But if we do, well, it would be a shock for which the United States would be completely unprepared.
Economic View: They dreamt that the money would just keep coming but one day Americans could wake up screaming -
Business Comment, Business - The Independent
I'm prepared.
I think the unauthorized discussions Merrill's CEO made could have some serious ramifications for all the players with their hand in the sketchy ABS cookie jar.
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
Laugh all you want, but a lot of bad news is, in fact, discounted into these (insurance) stock prices.
I see, possible bankruptcy is already priced in? LOL.
ALL: Basic Chart for ALLSTATE CP - Yahoo! Finance
Nemo says, "Insurance companies often have low P/E ratios because they have the "lumpiest" earnings of any industry."
You seem to imply that they don't do as well as the market, so they have low PE ratios. But the Yahoo chart indicates that several do quite a bit better than the market. I don't see the connection.
I see, possible bankruptcy is already priced in? LOL.
At 20% of book value, something approaching an 80% chance of bankruptcy is priced in. (Yes, yes, there are massive caveats to that statement... But it is close enough.)
So yes, "possible" bankruptcy is certainly priced in. Not for AIG... But for MTG and RDN? Absolutely.
James --
Where did I imply insurance stocks don't do as well as the market? Almost by definition, on average they do exactly as well as the market...
Insurance companies normally make good money. But once in a blue moon, when the big hurricane or earthquake or whatever hits their clients, they have to pay out big time. This is what I mean by "lumpy" earnings.
So in normal years, the market gives them a P/E ratio below the market average. In big payout years, the market gives them a P/E ratio (way) above the market average. That's because the stock price, in general, is anticipating future earnings over the long run, not just looking at the earnings for the past year.
The trailing twelve month P/E tells you nothing about whether an insurance company is "cheap" or "expensive". You have to know what they insure (and where), so you can find out whether they had a "normal" year or a "big pay out" year, before you can even begin to see any meaning in that P/E.
The P/E is misleading for any cyclical company. It is literally worthless for evaluating insurance companies.
Never in Union Pacific's 145-year history have there been as many opportunities for employment and rapid advancement as there are today. With baby boomers retiring in record numbers and the intense demand for our transportation services, we're hiring in unprecedented numbers in every part of our company.
We need good people. And we need them now.
mortgage pro's... there's always jobs...
Will they take them? It's was a once very proud job... in the 1860-1910 period...
In addition to that, any other ideas, anybody ?
-KI was sifting through some of the other books on structured finance and thought this comment from 2004 was insightfull:
But what I found most valuable was the focus on reduction-in-yield as the benchmark metric for ABS credit quality. Rather than credit ratings being an ex ante, handed-down-from-on-high, assumed-to-be-valid-within-a-notch-or-two inputs (which, I blush to admit, is how I too often think of them), the book points out how credit ratings should be thought of as a continuous, dynamic variable, interacting with the coupon, yield, prepayment vector, default vector, and triggers. The interactions are determined by cash flow modeling and Monte Carlo simulations, using the techniques mentioned above.
Given this framework and tools, the book discusses how to efficiently optimize the structured security. I have had ABS issuers ask if there were not a way to optimize securitizations beyond what they suspiciously perceived as Wall Street cookie cutter structures. Previously, I have just shrugged. Now I know how to help them. http://www.amazon.com/review/R2BF60EW3IPPMN/ref=cm_cr_rdp_perm/
I think you just need to pick a model you feel comfortable with. Use it as a crutch and convince other people of just how solid it is. Then hobble along for as long as you can until someone or something kicks that support out from under you.
Nemo, I haven't followed the insurance companies, but what you say makes sense. If I understand your "lumpy" earnings theme correctly, when you observe the earnings of the typical insurance company over time, the variance is very large relative to the mean. And if the market really does equate variance with risk, then the P/E ratio should be low at most times.
In addition to that, any other ideas, anybody ?
DefaultRisk.com The web's biggest credit risk modeling resource.
Doom,
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
Great comment.
-k SK,
I believe that you grossly underestimate the labor required to calculate all of the cashflows a CDO is entitled to every month.
With some simplifying assumptions & rounding: Lets assume we have a $1.5b CDO that is half subprime mortgages and half student loans. Average loan amount in subprime is around $175,000, avg. student loan amount is $20,000.
Subprime securitizations from 04-06 averaged about $1b apiece (5,714 loans per deal in our example). Student loan deals are $500m (25,000 loans)
The CDO purchases AAA bonds from 30 distinct subprime securitizations & 6 student loan securitizations.
Now lets figure how many loans we have to run to figure out what cashflows the CDO gets to collect every month:
How many deals do we have to run every month to get the underlying cash flows: 36
Why do we have to run the underlying deals? Because they each have their own cascading waterfall of principal & interest payment rules for each of the individual bonds in the deal.
So how many loans do we have to keep track of to pass through the principal & interest on in the underlying deals? 30 deals5,714 loans + 6 deals25,000 = 321,420 loans. We need to know the new unpaid balance is for each loan every month, the new coupon if the rate has changed, and the amount of gross losses & excess borrower coupon interest every month to build the overcollateralization or subordination in each of the 36 deals. Each deal has unique stepdown credit enhancement triggers that are assessed each month to see whether we build up credit enhancement or not.
When I get all of those 321,420 unique cashflows every month, then I can determine how the bonds get passed through the CDO bonds. Each of the underlying 321,420 cashflows are passed through CDOs principal & interest cascade to determine the payment owed on each of the CDOs bonds. At this 2nd level of securitization, we have to again calculate the amount of principal shortfall (gross losses) & excess/shortfall of coupon interest every month to determine the amount of overcollateralization & subordination.
HERE IS THE MONEY SHOT: So 321,420 loans per month, 37 deal structures, credit enhancements & triggers. We have to calculate all of these EVEN IF WE ONLY WANT TO ANALYZE ONE BOND IN THE CDO.
If I am a fixed income manager, and I have, say, 2 dozen CDO positions, multiply all of the numbers above by 24 if you want to model all of these on your own. This is why the rating agencies are so integral to the process. The complexity is mind-numbing for anyone trying to value a deal, rerate a bond, or restructure the mortgage of one of the homeowners.
That should be "then I can determine how the underlying bond cashflows get passed through to the CDO bonds."
Clyde,
This is why the rating agencies are so integral to the process. The complexity is mind-numbing for anyone trying to value a deal, rerate a bond, or restructure the mortgage of one of the homeowners.
Gahhh.
If your institutions' software is inferior to that of the RA, then you shouldn't be buying these sorts of securities at all. If your people can't do the work the RA's can do? You need better people. Relying on the RA's is a wonderful way to underperform (best case) or go broke.
I continue to wonder why the Feds haven't raided Bear Sterns? Wellcare must have been a priority.
Banker,
Your observation on the tightrope is central to my beef with the whole SIV structure being built on a duration mismatch...
Doom/Banker,
Sweeping the decks clean is SOP for a new CEO, and rigorously re-marking investments would certainly be part of this cleansing.
To me a really worrying thing would be if a major financial player replaced their CEO and (s)he didn't sweep the decks clean.
re: Clyde
I believe that you grossly underestimate the labor required to calculate all of the cashflows a CDO is entitled to every month.
I'm certain you are right about my estimation capabilities - and the example you've quoted is great in helping me scope the size of the problem. From a computing perspective, my rough calculation was around 30 million entity occurrences/month in the example - quite doable. The data model - loans, deal structures, CDOs, managers - seems straightforward. There are several computing hard aspects involved here but that's my biz so those I can handle.
I handle, just-cos-I'm-interested, 3 hourly weather forecasts at hourly intervals, 3 days forward, at 1.4 Km grid intervals across the entire Los Angeles basin, 7 days/week, 9 hours/week, ALL automated as part of my just-cos-I'm-interested pollution model. Modern computing tools really are very very good.
But of course, who's going to give me monthly cash flow data ? The government is very charitable with weather data so that was easy. Its not as simple as knocking on farm doors 600 miles away asking to buy GREEN peanuts ( just-cos-I-like-them) I expect but if I could solve that, I can have a heck of a bash at making progress on this.
Thanks again for the example. I'll work on it more.
-K
Dude or dudettes, as the case may be -- you were cited by Krugman:
Some housing pictures - Paul Krugman Blog - NYTimes.com
((fanboy mode off))
((fanboy mode on))
Congrats!!
((fanboy mode off))
energyecon,
As I noted before, you have really made me rethink things.
Stan O'Neal to be shot at dawn
Merrill Lynch Is Reported Ready to Dismiss Head - NY Times
sk, no point in working on the math now. Is that guy in Arizona done with those political simulations? Maybe your CPU-time would be better spent attempting to calculate time-until-pitchfork.
charles hugh smith-archive
coming to a bank near you soon?
"If there's one thing we know about the mortgage crisis, it's that it keeps turning policymakers and bankers into liars.
In June, Treasury Secretary Henry M. Paulson Jr. said mortgage problems "will not affect the economy overall." Merrill Lynch boss E. Stanley O'Neal said the mortgage mess was "reasonably well contained" the same month."
Peltz could mean a bumpy ride for Legg Mason -- baltimoresun.com
So, the investors didn't understand that the ratings agencies wouldn't understand that banks couldn't understand that the homeowners wouldn't understand loans that no one could understand.
Cue theme from 'The Sting,' as the handful of guys who understood laugh heartily in a warehouse full of cash.
Banker,
Jeez, tough crowd.
I dont believe (opinion here) many CDO investors playing in the AAA space modeled the AAA pieces of CDOs they purchased.
They relied on the rating agency stamp of approval at origination of the CDO. There is a much-higher likelihood that BBB buyers did their own modeling since they were taking on more risk.
The rating agencies were, and still are, an integral part of that process, busted as it is.
The Street creates complex securities, and investors looking for yield dont do what we consider prudent due diligence: they didnt model & stress the cashflows.
CDO cashflows are simply too complex for the average institutional investor to model.
Clyde, here is our latest CDO calculator:
CDO Price Calculator
Clyde: The CDO purchases AAA bonds from 30 distinct subprime securitizations & 6 student loan securitizations.
I think you have that wrong. AAA bonds didn't need to be packaged into CDOs, they had a market. The reason for creating CDOs as a means of getting higher rated securities from lower rated ones. Correct?
I believe, the subprime bonds packaged into CDOs were usually BBB and lower. That way, at least some part of them, could magically become AAA and AA CDO bonds.
Clyde: CDO cashflows are simply too complex for the average institutional investor to model.
I think the point being argued is, if that's the case, the institutional investors shouldn't be buying CDOs. Isn't that obvious?
-k SK,
Well, the biggest problem is building or renting & maintaining the cash flow "engine". The institutions that do model use Intex, Wall Street Analytics (although Moodys bought them so I don't know what they are called now) and there is a little cottage industry of consultants with proprietary engines. Some of the accounting firms still use spreadsheets, but they must be massive. You need the engine to run each of the loans every month (300k plus in our example, all of the numbers below will be from the problem posited in my prior post) comparing the cash received from the borrower to scheduled amortization called for in the mortgage note.
But even if you buy the engine, the crunching task is daunting.
The cashflows for each mortgage have to be run every month FROM INCEPTION; it is very difficult to start at month 6 or 12 because you need to have accurately modeled the overcollateralization & subordination & triggers every single month to know what the OC/sub/triggers are for each succeeding month.
The engine also has to be able to accommodate all of the math functionality needed to model the principal & interest payment rule cascades in the underlying 36 deals and the CDO itself. Very tricky, especially for a non-financial modeler.
To figure those out, you will have to read 37 prospectuses & purchasing & sales agreements (PSAs) and all of the side letters (hiding fees that should be in the prospectus). That is about 300-400 pages of documentation per deal, so 37x350 pages = 12,950 pages you will have to read word-for-word to accurately model the waterfalls.
All of the cashflows on the underlying deals have to be tied out to the bond payments & the OC/sub/trigger buckets, penny for penny. Then you would have to figure out a way to funnel the cash flows from the bonds you own on the underlying 36 deals SIMULTANEOUSLY to your CDO structure, once a month.
You pass the aggregate tied-out cashflows through the CDOs own principal & interest waterfall, which determines the principal & interest amounts passed to each of the CDO bonds. Then calculate & store the levels of the OC/sub/triggers for the CDO structure.
Every month. From inception. Even if you only own 1 bond in the CDO.
"...12,950 pages you will have to read word-for-word to accurately model the waterfalls."
No wonder scrap paper is one of the biggest US export items to China.
Clyde,
Isn't there also a fundamental problem that the risk assumptions that go into the mortgage instrument part of a CDO are unknowable?
I certainly have seen my share of clients who take incorrect transactional data, then spend lots of time analyzing it and producing published financial statements.
ozajh,
of course deck sweeping is SOP...but, as it's been discussed many times on this blog, it becomes a big deal when the arcane shit actually trades and marks other players to market, not to model.
Let's say Merrill cans the CEO and they get a new one? What would you do if you're the new guy? If I were him, I'd go through, dig up the old guy's bones, sweep the decks clean and point the finger at my predecessor. If that's what happens, then things get marked to market, not to model.
Scenario #1: the people who put the current CEO in place say "We made a fundamental mistake and need to change our direction completely."
Scenario #2: "We had the right basic idea, it's just that the current guy is corrupt and/or inept. Just get a better version of the same model and everything will be fine."
re:Clyde
To figure those out, you will have to read 37 prospectuses & purchasing & sales agreements (PSAs) and all of the side letters (hiding fees that should be in the prospectus). That is about 300-400 pages of documentation per deal, so 37x350 pages = 12,950 pages you will have to read word-for-word to accurately model the waterfalls.
All of the cashflows on the underlying deals have to be tied out to the bond payments & the OC/sub/trigger buckets, penny for penny. Then you would have to figure out a way to funnel the cash flows from the bonds you own on the underlying 36 deals SIMULTANEOUSLY to your CDO structure, once a month.
You pass the aggregate tied-out cashflows through the CDOs own principal & interest waterfall, which determines the principal & interest amounts passed to each of the CDO bonds. Then calculate & store the levels of the OC/sub/triggers for the CDO structure.
You bet. My, kinda rude but just to make the point thinking, around this is that the guys who wrote the prospectus were technical authors who worked through the computer programs/algorithms and just documented them - meaning that at source we had computing implementations of the schemes, SOMEWHERE. I'd asking for these schemes to be put in the public domain - that would of course make the task easier
Otherwise, it will have to be re-engineered. And, in my experience, its doable, but vastly speeded up as a result of help from insiders. ( An older experience of mine, from 199x/200x, is the way a group of people "decoded" and disseminated the workarounds for the region code lock on the APEX DVD player. Man, that region code pissed off people - it had shades of 1984 - dividing the world into Oceana, Eurasia, Eastasia - in it- thankfully, now, the unlocking mechanisms for so many DVD players are so widely distributed the whole edifice is worthless).
Your examples are great. Thanks.
-K
Clyde,
The calculation difficulty and the fact that raters got caught by that 'hundred year event' means that rating will cost more in the future. This whole thing has a long, long way to go before it is played out. At this point it is like the Tech stocks just at the end of their high flying days. When it is all through there will be structural changes in the mortgage business, in the rating business, in the investment banking business and possibly in some international relationships.
clyde:
It's amazing all the hard work that must be done for these things.
Given all the hard work that the Wall Streeters do, they should charge double so that they get a fair wage!
Bob-in-MA,
Dont shoot the messenger, just illustrating a complex system for our resident weatherman who wants to show his stuff. Whether CDO investors are negligent is another thread.
Banker hearts anyone for saying the rating agencies are an integral part of the process, but I say that precisely because most investors dont model AAA CDO bonds.
Big leaguers like him dont like sharing a locker room with high school talent (yes, the gap is that wide). But it is what it is: they literally line up against each other on each securitization (hundreds every month if you include all the asset classes, thousands every year).
The data I have on the AAA/BBB split for subprime paper in CDOs is at the office, I will produce it tomorrow. If memory serves, over 50% of CDOs are fed by mortgage cashflows, so subprime is a fraction of that mortgage slice.
Stag Mark,
Regarding your link above about the Seattle investment pool... It inadvertantly highlights a huge problem going forward for the CP market- that many of the investors are restricted in what they can buy. Thus, CP performance issues may cause a cascade effect which will further worsen future CP market performance...
From the article:
"But the turmoil in the U.S. mortgage markets has eroded the portfolio value of many SIVs, hampering their ability to redeem their commercial paper on time or refinance by issuing new paper." [snip]
"The pool is a sort of piggy bank where local governments can stash their excess cash until it's needed; by law, earning high returns takes a back seat to safety. As recently as two months ago, the pool had about $1 billion, or nearly 25 percent of its assets the statutory maximum invested in commercial paper."
"But after the investment rating of another commercial-paper fund in the pool's portfolio, Mainsail II, was cut to junk, the pool stopped buying new commercial paper."
Clyde is right. The problem with CDOs composed of tranches and hunks of other tranched/chunked pools of debt is that you have to model the performance of every one of the underlying pools to get the expected performance and valuation of your payment rights to that pool, then plug in all expectations of the individual pieces of the CDO to model its entire performance. Once you have done that, you can figure the valuation of your own chunk of the CDO.
This business really ran only on trust and confidence. These debt instruments are inscrutable.
Another problem is that the real performance of many of the underlying pools were not originally stress-tested, and it is hard to get the data to do so. For certain types of debt, there are failure correlations, so those should be included in the calculations.
Here is where a CR reader should reflect back to Tanta's comments about the Fitch assumptions and the problem with low/no doc or stated loans. If you don't know factors such as true starting DTI and occupancy, your evaluations of the underlying pools are sure to be highly problematic. Area risk is now a dominating factor for even prime loans, so you have to include that. Thornburg was hit by area risk.
Pools that were dominated by loans with prepayment charges and early ARM resets are now showing a slow rate of prepayment, which reduces the estimated payoffs for some of the tranches immensely.
The real assumptions backing a lot of the pool expectations and ratings were that housing would continue to appreciate into the foreseeable future, even if that appreciation slowed down to a nominal 5% or so, and that credit terms would continue to be as easy as they were at origination.
Of course neither assumption is now true.
The calculation difficulty and the fact that raters got caught by that 'hundred year event' means that rating will cost more in the future
yeah off course, i have a better proposal, outsource it to the bangalore street, it will be cheaper and have the same effect
IF you saw your name(oneal) in ill-reput spread across the nations rags, because you were playing the same game as all your competitors, what would you do on your last week in office?
Yearing to Learn,
I agree wholeheartedly.
The Wall Streeters are overworked,underpaid, cruelly mocked and misunderstood. Next time you see one, give them a hug
MOM, That's what I don't understand. Someone can design a very slick valuation model, but that means nothing if there's no integrity to the underlying data (including assumptions).
A CFO where I worked would berate people who didn't have firm foundations for budgetary numbers by telling them "so, why don't we just pick a number from the phone book!".
lama,
If all the mortgages in the 30 deals were prime mortgages and all the student loans in those 6 deals were to Ivy Leaguers, then the risks would be somewhat knowable.
Unlike market value problems in the SIVs, the risks in CDOs backed by mortgages are really at the borrower level. Not sure if there are SIVs in CDOs since I am a mortgage guy.
That is why Tanta's analysis on the ground from the battlefield is so striking: the biggest risk right now is severity of loss. A lot of these credit enhancements were sized with severities of 30-40% in mind (fhe old hands used 45-50%). But now we are getting severities north of that because of the bank/servicer inability to sell foreclosures at a market clearing price. When they finally throw in the towel, the carrying costs & servicing charges alone will put them over 50% (most of the defaulted mortgage payment is usually interest). Then there is the geographic death-spiral effect in places like the Inland Empire.
Think of the investor problem in terms of number of bonds owned. If you have 50 or 60 positions, you probably have 12-15 servicers working on your severity problems. If you diversified your holdings by asset class and geography and bought paper that was going to be serviced by a top quartile servicer, you can have a tighter dispersion on your guess for future severities, & thus future bond losses.
If you were not that diversified, the severity dispersion would be much wider. And if you did not control for credit by buying from servicers in the top quartile, your severities are going compound exponentially.
If you are an investor in the 2nd group, your risks are clearly not linear.
lama, banker, Bob-in-MA, MOM, et al
Going to be golfing for the next few hours, let's resume the modeling topic then.
It seems like the toughest part to the modeling issue is the initial data entry. Obviously all these parameters, as many as they may be, surrounding all the various loans making up the security can be modelled with computers. So, if you have the proper software, all one needs to do is feed it the info.
Even without the lack of documentation in recent mortgages, it seems to me data entry would be the most likely source of error.
sk
?)
Re: ( Do nerds even HAVE dicks
Ask Tanta.
Have fun...I'm with the flu, I'm going to start up the work computer and play with some flowcharts...wooo whooo!
Sunday Morning Ron Paul chuckles
Internet Defrag(myhat2u)
Ron Paul Election Complaint(myhat2u)
Good stuff at The Spoof
a few more
Exausted Ron Paul Spammer (funwithwords)
No mo pimpn Ron Paul (funwithwords)
"This business really ran only on trust and confidence. These debt instruments are inscrutable."
Some fantastic comments in here. At the end of the day MOM, that's the conclusion.
If you need a complex computer program and a staff adjusting the inputs every month and still not certain...OK...
Seems like the emerging reality is that we have over $1T in investment grade securities headed for junk. Do you know where your money is?
Caveat emptor...that's why many of us are sitting in US treasuries.
In regards to the CDO insurers, would they blindly accept the ratings of the underlying pools of mortgages or would they create their own and run their own loss models?
This business really ran only on trust and confidence. These debt instruments are inscrutable."
Nonsense. Why does AIG, for example, have over 100 fixed income analysts? What do you think the job of a number of those folks is???????
The idea that the RA are the paradigm of excellence and that the insitutions who bought this stuff are unable to apply the resources to figure this stuff out is laughable.
If the RA were viewed by the buyside as the arbiters, why do variuous AAA securities trade at disparate spreads? Because the market recognizes that the RA's are insufficiently granular in their analysis. If the RA's were relied upon the way some here claim, all commonly rated bonds of a given maturity and duration would trade withing a few basis points of each other. It doesn't remotely work that way.
Banker asks: Why does AIG, for example, have over 100 fixed income analysts?
In the hopes of getting two to agree?
So that when their models collapse they can say "over 100 analysts reviewed these instruments so don't blame us."
So they can segregate them into tranches and sell the worst analyses to customers and keep the best for themselves.
Because firing the 98 bad ones would leave them on the street where they can tell the truth.
Plausible deniability.
Banker - Why does AIG, for example, have over 100 fixed income analysts? What do you think the job of a number of those folks is???????
The insurance guys are taking and are going to take some severe losses of their own, thus proving that their analysis was faulty. MBIA, Ambac - they're all sitting in the hot seat now.
Obviously, they can't analyze effectively under these circumstances. Why is MBIA's SIV in such deep trouble? Their reported losses and anticipated losses make your argument something of a sick joke for anyone who owns stock in these companies.
And I know why they can't. They can't because of lack of underwriting control, which rendered all analysis an exercise in wishful thinking and blind trust.
Please understand what I am saying. I am not saying that these analysts connived in this. They had nothing to gain. I am not saying that they are stupid. Many of them have years of experience and highly successful track records. But they did operate in an environment which assumed that what was reported about loans was true, and that environment no longer exists.
Nobody can BS me on this. I know what needs to be done to implement controls at the institution and portfolio level, and one way or another, the same controls need to be available in longer chains of underwriting - and they haven't been since 2005. The appraisals were often crap and the DTIs are often effectively unknown or unverified. See Lama's comment.
I'm not going to mention any names, but I can tell you right now that the DTIs still being written at a bunch of the big boys are unstable. We have a long, long way to go in this credit correction. Things are going to get worse and not better, and part of the reason is that other forms of collateralized debt are getting in trouble as we speak. Those car loans and CC debt have lost their luster.
Nobody seems to register the real meaning of American Express commenting that revenues net of interest expense (which was higher) rose 12% in the third quarter for its US Card group. They say they got that on higher borrowing by consumers and small businesses. Well you don't see that in the stores, do you? A huge chunk of that went to pay bills and possibly other debt.
The correlations are moving higher every month, and that means the well is poisoned.
Banker,
No one on this thread said the rating agencies were excellent. You are on a jihad against them, and we don't know why.
I think most of us agree there is a wide gap in talent. Did one of them steal your girl friend or something?
Most of the hypotheticals we collectively have been speaking about are the challenges faced by the average institutional investor, not the AIGs of the world. And rating agencies continue to be on every deal, are they not?
This rating agency hangup of yours is the only blind spot that I have seen of yours. It is surprising. I am at a loss.
Robert Coté wrote...
Banker asks: Why does AIG, for example, have over 100 fixed income analysts?
In the hopes of getting two to agree?
Really funny!
Thanks to everyone who has contributed in todays comments.
My little contribution is ...
1) link to a September presentation by S&P that gives some statistics on CDOs and the contents thereof...
http://www2.standardandpoors.com/spf/pdf/media/subprime_revised_sp_asf_19sep07.pdf
Notice that even the high grade CDOs have about 10% in mezanine CDOs (very likely to default IMHO) - see pages 8 & 9.
2) A now somewhat dated set of presentations with historical issuance data on page 23.
http://www2.standardandpoors.com/spf/pdf/events/SubprimeMortgageMarket32907.pdf
3) A reasonable defense of S&Ps Structured Finance (SF) ratings work.
http://www2.standardandpoors.com/spf/pdf/media/082307_ian_op_ed_brt.pdf