And this from CNN: Quick housing rebound a question after missed '07 forecasts - Dec. 28, 2007
explains how 'they' got it so wrong on housing. No comments allowed-- otherwise I would have said the only people who got it wrong were the ones who had a vested interest in getting it wrong-- or who simply weren't paying attention.
"If a recession does occur, one can easily foresee a wave of defaults in junk bonds and their bank-loan cousins, leveraged loans. With highly leveraged structures supported by some of those loans, the surprises could be greater. It is sobering to realize that the issuing of leveraged loans set a record in 2007, even though the market contracted sharply late in the year."
It would be interesting to estimate the average cost of debt capital for 2,000 small public U.S. companies. I'm guessing it would be in the 9-12% range.
Then, you could look at how many small companies have used high-cost debt capital to leverage up earnings.
While nothing Floyd says is wrong, he missed the boat. What sits on top of that debt pyramid isn't bonds or loans. It's earnings and stock.
Like some healthy hedge funds, you could make a healthy living in this recession buying junk bonds and shorting the underlying stocks. Remember: Bondholders and loan-holders usually stand in line to get paid ahead of stockholders.
This is the biggest sign of how out-of-whack the stock market is...the flight from lower-rated debt combined with the flight to garbage stocks.
My brother in law is a middle market lender at BOA. His team came in first in his region. His Christmas gift from the boss? Rubber bands!
Seriously - 3 heavy duty black rubber bands with a small silver plate to dress it up a bit. You're supposed to wrap the band around your business cards to keep them organized.
As we commiserated with him on Christmas Eve - I told him - "We're all subprime now".
You'd think at some point these 'serious' journalist would be embarrassed that every analytical piece they write has been written several months earlier by people who actually understand what they're writing about.
(quote)
It was the greatest credit party in history, made possible by a new financial architecture that moved much of the activities out of regulated institutions and into financial instruments that emphasized leverage over safety. The next year may be the one when we learn whether the subprime crisis was a relatively isolated problem in that system, or just the first indication of a systemic crisis.
(end quote)
At what point will the recognition be made that the entire growth of the US economy after the dotcom bust was based on "financial innovation"?
And, that the pointy end of the upside down pyramid of "financial innovation" was on the shoulders of the mortgaging fool of a consumer?
You'd think at some point these 'serious' journalist would be embarrassed that every analytical piece they write has been written several months earlier by people who actually understand what they're writing about.
Oh, I think they understand. In fact, I'm sure they get their stories and facts from places like this. They probably have them all printed out and ready to go and just wait until the corporate editors give the ok. "alright, looks like this thing isn't going to blow over no matter how many happy economic outlook stories we run....might as well run that blogger's story now".
2008isgonnabegreat thanks for the link.
How they could dare to rate +75% of the CDO AAA although the whole CDO consisted only of BBB is beyond me.
I am no finance guy but I doubt that there is any way to present it mathematically based on the "standard" default expectation of the underlying BBB investments.
Working as a PM, my colleague kept on buying what I considered crappy corporates. I couldn't understand why he'd go for this junk when it was offering 20bps more than a Treasury. His answer was: "You can't look at the beeps, you have to look at it in % of historical spread or returns."
Tanta - thanks and thanks. For posting and also for linking. I confess the widening of the credit crisis across the housing markets AND then it's spread to other debt instruments has been a major concern of mine. Those flawed instruments were used to construct debt from many other markets from buyout loans to corporates. Plus, as we've learned with SIVs, there are intimate linkages to yet other asset classes, e.g. Commercial Paper and general credit quality. As CR in particular has been hammering.
And as you've been hammering in effect the incentives were to maximize the flow of originations not the quality since people made their money on the flow not on the return on investments.
These have concerned me enough to make a few stabs at grasping this mess myself and if anybody's interested they can try a few posts to see my "Rocks and Ponds" model of ebolistic contagions.
Rocks, Ponds & Perversions: http://tinyurl.com/24zuvo
Credit Mess Readings: http://tinyurl.com/22fl4y
Credit Avalanche Continues: http://tinyurl.com/2c2vyd
Greased Skids:Credit Repair Working ?: http://tinyurl.com/ytyyhc
After the funds of August, how can ANYONE still believe that this is a subprime problem? I mean, back in February somebody can be forgiven for believing that, but now?
I have been reading the PIMCO site for a while: nice Mr Gross has kept referring to the "finance-based" economy. Only slowly did I realise that he probably meant "fraud-based".
If you think Norris is slow, just waking up to the other stuff now, you should know that the venerable John Berry published a piece yesterday telling us all to calm down, because the dollar volume of subprime mortgages outstanding is under $200 bln. Period. I wonder if Norris isn't offering a sneaky response to Berry by pointing out that we have moved beyond that excuse.
FB's = smug
Norris = stupid and thus late; and as is obvious in the article, incapable of stating a probability outcome (other than his not being fired for incapacity to comprehend the present, never mind speculate or prognosticate the future).
In the case of RE, the boulder is careening down the hill. All he has to do is say, "Look! The boulder is coming."
"How they could dare to rate +75% of the CDO AAA although the whole CDO consisted only of BBB is beyond me."
Generally speaking, the 75% stuff will only default if the fund loses more than 25% of its value (actually, probably nearer 30% due to overcollateralization), because the lower tranches will take it in the shorts first.
So basically that means that Moody's and Fitch said that the probability of a loss severity that large was miniscule.
That said, the possibility of substantial writedowns in the portfolio was evident as early as January -- I came to this blog because I saw elsewhere that Tanta had been quoted about the Merrill "bloodbath" where scratch and dent loans were getting nuclear waste bids. That, I guess, was the Little Crunch, because it caused the credit markets to seize up.
Yet two months later the rating agencies hadn't noticed that Ownit was dead and that New Century was circling the drain: that means somebody was asleep at the switch in Ratingsville -- and that could be the smoking gun if the financial system implodes in a wave of subprime scandals.
Norris' key interviewee says something nonsensical, namely that leverage can magnify the total losses. This is plainly false. As a fraction of the size of an investment, leverage can make a loss bigger. But it doesn't have any effect on the dollar value of the loss.
What might be the case is that, through insurer bankruptcy or bank failure, the subprime losses may unearth previously unrevealed leverage elsewhere in the financial market. But a dollar of subprime loss can't become any bigger through that leverage.
"But a dollar of subprime loss can't become any bigger through that leverage."
Sounds like you read krugmans blog. But it can. To take just one example: the subprime free-and-easy credit flow inflated the values on homes. With the machine working in reverse now homes are pulling down the values of their neighbors (which got a free boost) and the result is the losses are spread around far more widely than the unfortunate family foreclosed or bank holding the note. In that sense the subprime lending has "leveraged" itself into much wider losses just as it "leveraged" higher asset values everywhere during the lending boom.
Alistair, yes thanks but still, if I am not wrong Norma was done (March 2007) when even I saw that things were changing(I don't have to list all points here but if I remember the super low default rates were already rising in the beginning of 2007) Anyway calculating things while only using the last leg up of price history and not the older ups and downs and mean housingprices is unbelievable to me, for a rating company at least. Our Austrian state railway switched into one of these CDOs on recommendation about that time for 1 Billion$, they have not yet informed the public about the full "value" remaining...
That was an interesting story and if you think about the flood of cheap easy money, the easy liquidity period, all that happened was Bank Of Japan ramped the yen printing press up to warp speed and flooded our banking system with bogus cash!
Hey Tanta,
please cut Floyd some slack, after all he only recently heard about Nina loans so how was he supposed to know that the sh*t is already hitting the fan big time?
Re: n a press conference, Attorney General Spitzer indicated, as referenced by the title of his Press Release, "Investigation Reveals Widespread Corruption In Insurance Industry", that as the investigation continues, it could proceed further into property & casualty, expand into auto, health and other areas of insurance. "Trust me," Spitzer said upon filing his complaint against Marsh, "this is Day 1".
New York State Attorney (AG) General Eliot Spitzer Charges "Widespread Fraud And Corruption" And Illegal Activities As Common Practices Against The Insurance Industry. The NY AG Along With A Number Of Other States Attorney Generals (AG) Offices Playing Significantly Lesser Roles, The SEC (The Securities and Exchange Commission), The NAIC (The National Association of Insurance Commissioners), A Handful Of DOIs (The States Departments Of Insurance) And Authorities Also Commit To Investigate.
But a dollar of subprime loss can't become any bigger through that leverage.
It depends on who's loss. Total loss (of all accounts) or the principals loss or the losses of the lenders providing the leverage.
If I am leveraged 9 to 1 (total placement of 10)... and I lose 1% of the total 10... that's still only 1%... but to ME its a 10% loss. For the lender its still a zero percent loss.
10% is bigger than 1% for me and zero is smaller than 1% for them... but the overall is still 0nly 1% of the total placement.
But do I give a rats ass about the lucky lender if my principal gets whacked 10%? Nor would the lender care UNLESS the backslide trips over the 9:1 line into his position (well actually sooner if he fears his interest is also at risk - but that's details).
Generally speaking, the 75% stuff will only default if the fund loses more than 25% of its value (actually, probably nearer 30% due to overcollateralization), because the lower tranches will take it in the shorts first.
The problem is that pooling has become so pervasive that a national market was created. Therefore losses became much more corelated than heretofore. During a regional decline, pooling across regions would reduce losses to the upper tranches because only properties in a declining region (say the oil patch) would decline, keeping the losses safely in the lower tranches. But with a national (or at least widely distributed) price bubble, prices in CA and FL and MA and MD are all going down at once. Pooling across regions helps save the upper tranches NOT ONE WHIT. Especially when you're pooling 2nds where defaults can give you total losses of principal, I don't see how the pooling and tranching can reduce losses except for a small fraction of bondholders.
Pay no attention to the man behind the curtain.
And this from CNN:
Quick housing rebound a question after missed '07 forecasts - Dec. 28, 2007
explains how 'they' got it so wrong on housing. No comments allowed-- otherwise I would have said the only people who got it wrong were the ones who had a vested interest in getting it wrong-- or who simply weren't paying attention.
I thought there were a few things we all agreed on.
1) Commercial real estate generally lags Residential
2) The NY Times generally lags Tanta by 3-6 months.
"If a recession does occur, one can easily foresee a wave of defaults in junk bonds and their bank-loan cousins, leveraged loans. With highly leveraged structures supported by some of those loans, the surprises could be greater. It is sobering to realize that the issuing of leveraged loans set a record in 2007, even though the market contracted sharply late in the year."
It would be interesting to estimate the average cost of debt capital for 2,000 small public U.S. companies. I'm guessing it would be in the 9-12% range.
Then, you could look at how many small companies have used high-cost debt capital to leverage up earnings.
While nothing Floyd says is wrong, he missed the boat. What sits on top of that debt pyramid isn't bonds or loans. It's earnings and stock.
Like some healthy hedge funds, you could make a healthy living in this recession buying junk bonds and shorting the underlying stocks. Remember: Bondholders and loan-holders usually stand in line to get paid ahead of stockholders.
This is the biggest sign of how out-of-whack the stock market is...the flight from lower-rated debt combined with the flight to garbage stocks.
Gadzooks! 'Tis enough to make one's blood run cold!!!
My brother in law is a middle market lender at BOA. His team came in first in his region. His Christmas gift from the boss? Rubber bands!
Seriously - 3 heavy duty black rubber bands with a small silver plate to dress it up a bit. You're supposed to wrap the band around your business cards to keep them organized.
As we commiserated with him on Christmas Eve - I told him - "We're all subprime now".
Exactly 12th.
You'd think at some point these 'serious' journalist would be embarrassed that every analytical piece they write has been written several months earlier by people who actually understand what they're writing about.
More on CDOs from the WSJ with background on Norma and don't miss the cool interactive on how a mortgage CDO works.
Wall Street Wizardry Amplified Credit Crisis - WSJ.com
From the article:
(quote)
It was the greatest credit party in history, made possible by a new financial architecture that moved much of the activities out of regulated institutions and into financial instruments that emphasized leverage over safety. The next year may be the one when we learn whether the subprime crisis was a relatively isolated problem in that system, or just the first indication of a systemic crisis.
(end quote)
At what point will the recognition be made that the entire growth of the US economy after the dotcom bust was based on "financial innovation"?
And, that the pointy end of the upside down pyramid of "financial innovation" was on the shoulders of the mortgaging fool of a consumer?
Only a few failures away from meltdowm.
You'd think at some point these 'serious' journalist would be embarrassed that every analytical piece they write has been written several months earlier by people who actually understand what they're writing about.
Oh, I think they understand. In fact, I'm sure they get their stories and facts from places like this. They probably have them all printed out and ready to go and just wait until the corporate editors give the ok. "alright, looks like this thing isn't going to blow over no matter how many happy economic outlook stories we run....might as well run that blogger's story now".
2008isgonnabegreat thanks for the link.
How they could dare to rate +75% of the CDO AAA although the whole CDO consisted only of BBB is beyond me.
I am no finance guy but I doubt that there is any way to present it mathematically based on the "standard" default expectation of the underlying BBB investments.
Working as a PM, my colleague kept on buying what I considered crappy corporates. I couldn't understand why he'd go for this junk when it was offering 20bps more than a Treasury. His answer was: "You can't look at the beeps, you have to look at it in % of historical spread or returns."
And this guy was considered VIP.
There was no place for realists, period
Tanta - thanks and thanks. For posting and also for linking. I confess the widening of the credit crisis across the housing markets AND then it's spread to other debt instruments has been a major concern of mine. Those flawed instruments were used to construct debt from many other markets from buyout loans to corporates. Plus, as we've learned with SIVs, there are intimate linkages to yet other asset classes, e.g. Commercial Paper and general credit quality. As CR in particular has been hammering.
And as you've been hammering in effect the incentives were to maximize the flow of originations not the quality since people made their money on the flow not on the return on investments.
These have concerned me enough to make a few stabs at grasping this mess myself and if anybody's interested they can try a few posts to see my "Rocks and Ponds" model of ebolistic contagions.
Rocks, Ponds & Perversions: http://tinyurl.com/24zuvo
Credit Mess Readings: http://tinyurl.com/22fl4y
Credit Avalanche Continues: http://tinyurl.com/2c2vyd
Greased Skids:Credit Repair Working ?: http://tinyurl.com/ytyyhc
After the funds of August, how can ANYONE still believe that this is a subprime problem? I mean, back in February somebody can be forgiven for believing that, but now?
"funds of August"
ha ha - clever
"There was no place for realists, period."
Epithet for the early 21st century.
"funds of August"
ha ha - clever
--As much as I'd like to take credit for it, it's not mine. But imitation is the sincerest form of flattery....
I have been reading the PIMCO site for a while: nice Mr Gross has kept referring to the "finance-based" economy. Only slowly did I realise that he probably meant "fraud-based".
If you think Norris is slow, just waking up to the other stuff now, you should know that the venerable John Berry published a piece yesterday telling us all to calm down, because the dollar volume of subprime mortgages outstanding is under $200 bln. Period. I wonder if Norris isn't offering a sneaky response to Berry by pointing out that we have moved beyond that excuse.
I was really surprised at Berry.
FB's = smug
Norris = stupid and thus late; and as is obvious in the article, incapable of stating a probability outcome (other than his not being fired for incapacity to comprehend the present, never mind speculate or prognosticate the future).
In the case of RE, the boulder is careening down the hill. All he has to do is say, "Look! The boulder is coming."
Too taxing for Norris.
"How they could dare to rate +75% of the CDO AAA although the whole CDO consisted only of BBB is beyond me."
Generally speaking, the 75% stuff will only default if the fund loses more than 25% of its value (actually, probably nearer 30% due to overcollateralization), because the lower tranches will take it in the shorts first.
So basically that means that Moody's and Fitch said that the probability of a loss severity that large was miniscule.
That said, the possibility of substantial writedowns in the portfolio was evident as early as January -- I came to this blog because I saw elsewhere that Tanta had been quoted about the Merrill "bloodbath" where scratch and dent loans were getting nuclear waste bids. That, I guess, was the Little Crunch, because it caused the credit markets to seize up.
Yet two months later the rating agencies hadn't noticed that Ownit was dead and that New Century was circling the drain: that means somebody was asleep at the switch in Ratingsville -- and that could be the smoking gun if the financial system implodes in a wave of subprime scandals.
Norris' key interviewee says something nonsensical, namely that leverage can magnify the total losses. This is plainly false. As a fraction of the size of an investment, leverage can make a loss bigger. But it doesn't have any effect on the dollar value of the loss.
What might be the case is that, through insurer bankruptcy or bank failure, the subprime losses may unearth previously unrevealed leverage elsewhere in the financial market. But a dollar of subprime loss can't become any bigger through that leverage.
"But a dollar of subprime loss can't become any bigger through that leverage."
Sounds like you read krugmans blog. But it can. To take just one example: the subprime free-and-easy credit flow inflated the values on homes. With the machine working in reverse now homes are pulling down the values of their neighbors (which got a free boost) and the result is the losses are spread around far more widely than the unfortunate family foreclosed or bank holding the note. In that sense the subprime lending has "leveraged" itself into much wider losses just as it "leveraged" higher asset values everywhere during the lending boom.
Alistair, yes thanks but still, if I am not wrong Norma was done (March 2007) when even I saw that things were changing(I don't have to list all points here but if I remember the super low default rates were already rising in the beginning of 2007) Anyway calculating things while only using the last leg up of price history and not the older ups and downs and mean housingprices is unbelievable to me, for a rating company at least. Our Austrian state railway switched into one of these CDOs on recommendation about that time for 1 Billion$, they have not yet informed the public about the full "value" remaining...
That was an interesting story and if you think about the flood of cheap easy money, the easy liquidity period, all that happened was Bank Of Japan ramped the yen printing press up to warp speed and flooded our banking system with bogus cash!
DH
Hey Tanta,
please cut Floyd some slack, after all he only recently heard about Nina loans so how was he supposed to know that the sh*t is already hitting the fan big time?
Anyone think buffett is out of control?
Re: n a press conference, Attorney General Spitzer indicated, as referenced by the title of his Press Release, "Investigation Reveals Widespread Corruption In Insurance Industry", that as the investigation continues, it could proceed further into property & casualty, expand into auto, health and other areas of insurance. "Trust me," Spitzer said upon filing his complaint against Marsh, "this is Day 1".
New York State Attorney (AG) General Eliot Spitzer Charges "Widespread Fraud And Corruption" And Illegal Activities As Common Practices Against The Insurance Industry. The NY AG Along With A Number Of Other States Attorney Generals (AG) Offices Playing Significantly Lesser Roles, The SEC (The Securities and Exchange Commission), The NAIC (The National Association of Insurance Commissioners), A Handful Of DOIs (The States Departments Of Insurance) And Authorities Also Commit To Investigate.
But a dollar of subprime loss can't become any bigger through that leverage.
It depends on who's loss. Total loss (of all accounts) or the principals loss or the losses of the lenders providing the leverage.
If I am leveraged 9 to 1 (total placement of 10)... and I lose 1% of the total 10... that's still only 1%... but to ME its a 10% loss. For the lender its still a zero percent loss.
10% is bigger than 1% for me and zero is smaller than 1% for them... but the overall is still 0nly 1% of the total placement.
But do I give a rats ass about the lucky lender if my principal gets whacked 10%? Nor would the lender care UNLESS the backslide trips over the 9:1 line into his position (well actually sooner if he fears his interest is also at risk - but that's details).
That's the miracle power of gearing in reverse.
Generally speaking, the 75% stuff will only default if the fund loses more than 25% of its value (actually, probably nearer 30% due to overcollateralization), because the lower tranches will take it in the shorts first.
The problem is that pooling has become so pervasive that a national market was created. Therefore losses became much more corelated than heretofore. During a regional decline, pooling across regions would reduce losses to the upper tranches because only properties in a declining region (say the oil patch) would decline, keeping the losses safely in the lower tranches. But with a national (or at least widely distributed) price bubble, prices in CA and FL and MA and MD are all going down at once. Pooling across regions helps save the upper tranches NOT ONE WHIT. Especially when you're pooling 2nds where defaults can give you total losses of principal, I don't see how the pooling and tranching can reduce losses except for a small fraction of bondholders.