Builders Giving Up On The Sinking Market (4 Trillion in Losses)

CBS News ^ | Oct. 10, 2007 | CNS

[NVDave]

EXACTLY. You’ve nailed it dead-on in the X-ring.

And that’s the problem here. When I read the fine print in the 10K/Q’s coming out of banks right now, it is quite clear that they’re rather uncertain where this sub-prime crap is going to show up next in their portfolio. Citi announced a big miss in earnings and big write-downs only two weeks ago... and this past Monday, they had to enter the confessional *again*. It is clear that these guys don’t know where they buried all the landmines they bought.

Here’s the thing to remember: If I just bundled $1 million of sub-prime and $99 million of US Treasuries together and sold that to you, would you pay me a premium for that aggregate bond over what you’d pay for $1 mil of sub-prime and $99 mil of US Treasury debt? Of course not. You could go out and buy the same paper all by yourself. Why do you need to pay me, a commercial paper huckster?

But if I package all of it together, toss in a few debt derivatives to supposedly compensate for changes in interest rates and yield issues... and I make it sufficiently complicated that you can’t immediately understand it without running my simulation s/w... will you buy it? If I make it appear that you’re getting a higher yield on my instrument, you might be interested.

Then you’ll ask about the quality of the debt.

So I get the ratings agencies to declare that it is “the same as AAA government debt.” Never mind that this assessment is complete and total bullcrap. Moody’s, Fitch’s or S&P says it is gold-plated debt paper. Now I’m offering you a yield premium that exceeds what you get on other AAA paper, but with a AAA rating. Do you buy it now?

Sure. You jump on the deal with both feet!

And that’s what too many banks and debt buyers did. They believed the absurd ratings put onto these things and they bought them.

Trouble is, they’re not AAA. As one AXA money-market-like fund in Europe found out, these things are not anywhere close to being AAA. They lost 25% of the face value in two weeks on some CDO’s they had in a money-market type fund.

This landmine-like behavior now has both the banks and the SEC combing through bond portfolios, looking for all the hidden sub-prime crap out there. The bankers want to break it apart (a sound idea) and re-rate the sub-prime stuff (an even more sound idea) and call AAA paper AAA and sub-prime paper “junk” and adjust the yield/risk pricing appropriately. Which, of course, is what should have been done in the first place.

This is the central problem with the default rates. In absolute terms, you’re absolutely right about how small a slice of the whole mortgage market the sub-prime stuff is. The problem is that that little bit of the market has been chopped up and injected into debt instruments all over the debt markets, and people who previously had been pleased with the higher-than-normal yields on these instruments are now wondering “Uh.... so if the default rates go up another 0.1%, is that when *my* CDO blows up?”

[Eagles Talon IV]

It seems to me that if a broker represents a debt package as AAA and it turns out not to be as advertised then the seller of that package ought to be responsible for any losses directly attributable to his misrepresentation.

[NVDave]

In some cases, you’re right - there are “covenants” placed on the bonds which force the issuer of the debt to buy back the bones if the performance of the debtholders paying back the principle default above a certain rate.

Attempts to force the issuers of some of this sub-prime paper has bankrupted more than a couple of the mortgage lenders in the sub-prime market. So the bond holder still ends up with a problem on their hands.

Ultimately, the problem goes back to the rating agencies. (S&P, Fitch’s, Moodys)

There’s no way that some combination of sub-prime+prime+treasuries is as safe as a pure, simple US Treasury bond. Just no way. It would be like me trying to peddle some amalgam of gold, silver, etc to you and claim that it was every bit as valuable as 24K gold. You and every other person with common sense would say “Huh? No way. It is either pure gold, or not. If it isn’t, I’m not paying pure gold prices for it.” Yet, that’s exactly what these CDO issuers, the ratings agencies, etc were claiming.

The ratings agencies have been fully complicit in helping peddle this trash+ debt to banks, people, funds, etc seeking higher interest rate paper that was perceived as “safe.” Sadly, there’s no way to recover anything from the ratings agencies.

[Uncle Hal]

Amy will only lose money if she sells her house for a loss. Just hold onto the house for a few years and she will probably come out OK. A house is a place to live. You have to live someplace.