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Author: Subject: To buy or not to buy toxic assets...your thoughts on the financial bailout

Maximum Peach





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  posted on 2/9/2009 at 04:42 PM
So I know we discussed this previously, but I would be interested to get people's opinions who work in finance or related fields on the renewed push of buying bank's bad assets, and if you think its a good or bad idea. Things change so fast in this world, would love to hear if you guys have changed your mind on the bank bailout or the different programs in place. With respect to buying toxic assets, some have talked about a sort of reverse auction, but a part of me thinks that might open a real can of worms and expose the actual price investors are willing to pay, which could be far less than most expect, thereby making things worse for the banks. I also saw something where Gheitner was thinking about changing mark to market accounting again (wouldn't that be great, we could hold our houses at values from a few years ago...yeah right!!). I ask because I have many clients who have portfolios where the mark to market changes are violent (understatement of the year) but the bonds are still cash flowing, i.e paying principle and interest. In the structured finance world, its seems to me that you don't lose money on a bond because of liquidity (which has led to many of these mark to market changes), but rather you would lose money due to credit issues.

By the way, I don't think this is a bad idea in theory, I am just unsure how they are going to arrive at prices that are beneficial to the banks. Not really sure what the solution should be at this point.

The whole bank bailout is vexing for me. One part says, f*ck it, let them go down, the other says, they had to do it. Looking historically, specifically 1907 and 1920, it seems, amazingly, doing nothing often seemed to be the correct response. Whether that was because they just didn't know what to do or how to use the tools at their disposal, I don't know, but those two depressions were over within a year, and the federal government did pretty much nothing. Yet, the federal government got involved during the Great Depression and that lasted about 10 years. I don't know what to think anymore. Eventually, we are going to have to face the grim reaper.

 
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Zen Peach



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  posted on 2/9/2009 at 05:21 PM
http://www.allmanbros.com/modules.php?op=modload&name=XForum&file=v iewthread&tid=87891

http://www.allmanbros.com/modules.php?op=modload&name=XForum&file=v iewthread&tid=87811

http://www.allmanbros.com/modules.php?op=modload&name=XForum&file=v iewthread&tid=87754

 

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Maximum Peach



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  posted on 2/11/2009 at 08:44 PM
I certainly don't work in finance or anything related, but I'll comment. I visited the other threads linked here and there wasn't a whole lot of bad asset talk.

Depending on one's outlook, I'm not convinced we should, but if this is the hump we absolutely need to get over then the creation of the bad bank is interesting. The problem has always been, and continues to be, how do the assets get valued. Private capital is on the sidelines thinking they are still too high. Banks don't want to cut them loose at firesale prices thinking they are going to get a better deal from the Government. This thing is like a catch 22, it has to be enough to actually help the banks, but not too much that the tax payers get screwed. Either way we are talking about atleast 2 trillion, if not multiple trillions for all troubled assets on bank balance sheets - something that could be $5 trillion in total according to a BW story I was reading. W O W

Just a question, when does the world run out of money to lend us and when does our printing press run out of ink?

 

Maximum Peach



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  posted on 2/11/2009 at 08:45 PM
Oh yeah and I heard a change in terminology on this. They aren't toxic assets anymore, now they are legacy assets!
 

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  posted on 2/12/2009 at 07:56 AM
This is an interesting take on the bad assests (from Ezra Klein):

An oft-quoted investment banker e-mails us: “There is no capital in the entire global financial system. None. When I say ‘financial,’ I mean banks, hedge funds, private equity funds, homeowners and other leveraged players. There is some capital among the ‘real money’ players such as sovereign wealth funds and central banks. And the U.S. can ‘print’ some. But that's it. … The problem with the distressed assets is not that there are no buyers. There are plenty of buyers; I speak to them every day. The problem is there are no sellers; that is, the banks won't sell. Because to sell is to book a loss on what you have sold and what remains. And to do that is to die. That's what it means to be insolvent.”

Just to clarify those last sentences: The banks bought the bad assets at high prices. They need to sell them at low prices. But this banker is arguing that they are too financially stressed to absorb the losses that would entail. Conversely, so long as they don't sell the assets, they can pretend they haven't lost any money on them, as they can pretend that they will rebound to a better price once the mania is over. The other way of putting this is that much of the banking sector is already insolvent, it's just not prepared to admit it.

 

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Ultimate Peach



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  posted on 2/12/2009 at 10:33 AM
Goliath, that is an astute analysis with one exception, the word "insolvent".

Insolvent is the inability to meet obligations when they come due. The impairment of assets is a catastrophic event to the balance sheet, but, it's not cash. So long as these entities can remain liquid, (for a bank, that means no run on the deposits and the availability of short term borrowings, from other banks or the Fed) then they remain solvent and in no danger of failure.

This really gets to the mark to market argument...accounting insists on valuing long term assets (such as those whose underlying value is tied to real estate) using current market conditions. It's not realistic to value an asset at what you could sell it for today, when you have no intention of doing so. Especially instruments tied to long term, cyclical assets.

 

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Maximum Peach



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  posted on 2/12/2009 at 12:35 PM
quote:
This really gets to the mark to market argument...accounting insists on valuing long term assets (such as those whose underlying value is tied to real estate) using current market conditions. It's not realistic to value an asset at what you could sell it for today, when you have no intention of doing so. Especially instruments tied to long term, cyclical assets.
You're spot on with this.

It's a little too simplistic to say that the banks just won't sell and that's the issue. In fact, you could make an argument that they don't need to sell them. They're still performing assets. The companies that hold them (the banks) have just gotten killed in the valuation mess. A lot of it just comes down to valuation.

 

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Maximum Peach



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  posted on 2/12/2009 at 01:40 PM
quote:
Goliath, that is an astute analysis with one exception, the word "insolvent".

Insolvent is the inability to meet obligations when they come due. The impairment of assets is a catastrophic event to the balance sheet, but, it's not cash. So long as these entities can remain liquid, (for a bank, that means no run on the deposits and the availability of short term borrowings, from other banks or the Fed) then they remain solvent and in no danger of failure.

This really gets to the mark to market argument...accounting insists on valuing long term assets (such as those whose underlying value is tied to real estate) using current market conditions. It's not realistic to value an asset at what you could sell it for today, when you have no intention of doing so. Especially instruments tied to long term, cyclical assets.


If insolvency was an asset vs liability equation, then Citi and BOA would be walking a thin line. I read that BOA's assets only exceed their liabilities by 10%. Last fall Citi was at 5.2% - that is fairly dangerous territory right? Any further decline in assets or increase in liabilities could break them?

How does a company like BOA get out of the hole when they have to pay the govt dividends amounting to $5billion a year as part of it's bailout?

I just skim the surface with this stuff, I really don't understand it beyond a surface level, but there is an argument for the mark to market rule is there not? In this environment, maybe any case for the market to market accounting is out the window.

 

Maximum Peach



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  posted on 2/12/2009 at 01:43 PM
Oh, and on CNBC this morning the Administration's Chair of Economic Advisers used the term legacy assets after Mark Haynes called them toxic assets. Hey Fujirich, add that one to your Obamized language.
 

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  posted on 2/12/2009 at 01:44 PM
quote:
If insolvency was an asset vs liability equation, then Citi and BOA would be walking a thin line. I read that BOA's assets only exceed their liabilities by 10%.


Excellent point. BoA hung quite the albatross when they took on all of that subprime Countrywide debt.

quote:
How does a company like BOA get out of the hole when they have to pay the govt dividends amounting to $5billion a year as part of it's bailout?



Take a radical approach to making their mortgage portfolio perform, for one.

Someone had mentioned that the size of the stimulus package was enough to pay off every mortgage in America. That wouldn't have been such a bad idea, really...

 

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Maximum Peach



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  posted on 2/12/2009 at 01:47 PM
quote:
Someone had mentioned that the size of the stimulus package was enough to pay off every mortgage in America. That wouldn't have been such a bad idea, really...


That's what I thought too! If we are going to throw money at the problem and abandon principles why not just do it right?

 

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  posted on 2/12/2009 at 02:25 PM
Nebish, good question, but as Brendan pointed out, these assets that are being written down in value, are not necessarily not performing.

For example, say BofA holds a $100MM mortgage backed security - that is, a portfolio of mortgages totaling $100MM. Some, most, of the underlying loans are paying. Let's for argument say 10% are past due. But even those 10% aren't worthless, maybe you can foreclose the mortgage and sell the property for 50% of the loan value (that's extreme). So, the MBS is worth somewhere in the vicinity of $90-95MM depending on the rate.

In all likelihood, because there are no buyers for this MBS, its value might be $75MM. That $25MM writedown is a big hit to capital, but the real issue is the cash flow coming from the MBS. Is its value what you could sell it for, or what it earns you?

Simpler answer...the local pizza guy's storefront cost him $100,000 and that's what it would be valued at on his balance sheet. But it's only worth $75,000 today. However, even in this economy, people are eating pizza, so he has no intent of selling. He's still earning $100,000/year selling pizza and Foxon Park soda. Current accounting treatment wouldn't require him to impair the value of his store until he sold it. MBS are treated differently.

Underlying much of the capital issues in the financial services industry is the performance of the underlying debt - be it a resi mortgage, consumer loan, credit card, commercial loan, whatever. Financial companies have been forced to write these loans/securities down below the level of what their cash flows would suggest they're worth. If delinquencies rise, those cash flows decline and justify the paper writeoffs. If the economy and job market recover, and the loans pay, then there will be paper gains offsetting the losses.

I'm not suggesting that these writedowns aren't legitimate, the economy sucks and there are going to be loan losses. But I do believe that the pendulum probably swung too far and that there is value to be recovered in some of these assets. Of course, there were MANY loans poorly underwritten, and those chickens will come home to roost, but I don't believe that's the case with every dollar of capital written off.

 

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Universal Peach



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  posted on 2/12/2009 at 02:39 PM
WOW! I AM TRULY STUNNED!!!

I very rarely venture over here, occasionally to check the MT thread. Saw this topic, decided to venture in. I am STUNNED at the quality of the posts in this thread. Didn't realize there were a number of folks around that actually knew what they were talking about! Very refreshing.

I watched nearly all of the House Financial Services hearings yesterday, kinda' part of my job. The stunning thing there was how gross ignorant most members of the committee were as to how the banking system actually works. You would think they or their staffs would have some expertise, or at least some fundamental knowledge of how the financial system and the credit markets work in order to be appointed to this committee.

House staffers wrote the stimulus package, and I don't know if it's a good or bad thing.
But what I saw yesterday was truly troubling, if it reflects the lack of basic knowledge of how things work that went into the bill. Add Shelby and Dodd in the Senate....we're not in good hands when it comes to hard financial policy, I fear.

NOW....as to why I visited the thread in the first place....toxic assets.
There was a small article in our local paper yesterday. About an auction that took place over the weekend. 69 condo units, facing the gulf, at Gulf Shores, Ala. Handled by National Auction Group, of Gadsden. Brought about 50 cents on the dollar of asking price.
Over 260 qualified bidders, from 30 states. The developers, in Calif., were very pleased.

This is the final solution to the situation. Only thing that works. Get these properties into viable hands, at any price. We can't go forward economically until this is done, imho.
All the rest is smoke and mirrors.

Let us revisit the last similar mess, the S&L situation in 1989-1992. The current situation is very similar, imho. More intense, not exactly the same. But similar.
How was that resolved? The FSLIC (same as the FDIC, except for savings & loans) took over the failed S&L's, the government paid off the depositors, took over the assets.
The non-performing and foreclosed were placed in an entity called the Resolution Trust Corporation, and auctioned off over a period of time. Two local companies, National Auction Group and J.P. King, handled much of the auctions nationwide. The government (Treasury) received the proceeds less auction fees, and the government actually made a nice profit in the end. Over 300 S&L's were liquidated this way.

The government had to raise taxes to pay off the depositors, and it cost Bush I reelection when he reneged on his pledge, "Read my lips-no new taxes." The higher taxes also put the country in recession.

Here's what is different this time. We are talking large, large institutions this time. And, as we have seen, common shareholders are being wiped out or almost wiped out, as in the S&L situation. But here is what is different, and what makes this problem so hard to solve. These institutions have vast issues of bonds, commercial paper, and preferred stock on the market.

Let us look at the situations that evolved after the failure of Bear Stearns, then at the Lehman situation. When Bear Stearns became illiquid (not insolvent), the Fed engineered a takeover at $10 a share. Thus common holders had their holdings liquidated at this price. But the aquiring company also aquired, along with the assets of the company, the liability for the bonds, preferred, and commercial paper. Thus, these entities remained viable on the books of their owners.

In the Lehman situation, the company was allowed to fail outright. This meant that not only common stock holders, but also preferred holders and commercial paper holders saw the value of their holdings go to zero overnight. Bondholders eventually got about 93 cents on the dollar as I remember, but about 80 cents of this came from credit default swaps issued primarily by AIG, making them illiquid.

The result of the Lehman situation was a freezing of the credit markets. Just one small example--Goodyear, like most companies, keeps short term cash in a money market fund.
When Lehman commercial paper failed, the money market fund that Goodyear uses "broke the buck" and also failed. Thus $325M of Goodyears $425M liquid money was inaccessable. They drew down all their $615 line of credit to make payroll and pay suppliers. Nothing at all wrong with Goodyear, but they almost went under through no fault of their own, no business-related problems. Many weeks later, the fund was liquidated, and they received around 94 cents on the dollar. On "liquid" money.

Another casualty was the Retirement Systems of Alabama. The system lost 4% of its value due to exposure to Lehman bonds and preferreds.

So here is the quandary. The toxic assets need to be auctioned off by somebody....the government or the current holders. Get the property into viable hands no matter at what price. And at the same time, preserve the integrity of the fixed issues of the holders. That is the challenge that Gientner (sp), Barnarke, and Volker face.

 
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  posted on 2/12/2009 at 03:22 PM
Buppalo1 - a play out of a book that has worked before....but, the biggest criticism of that method is that it forces further writedowns as it becomes a fire sale/auction instead of an orderly sell out which would preserve value.

As we've discussed, especially as it pertains to real estate, these are long term assets and we're forcing valuations and sales at distressed prices, in some cases with no reason to force the issue. We'd also be forcing the sale of assets at a time when traditional lenders are not lending, making financing hard to come by, further distressing values (although rates couldn't be much lower, could they??)

Would we be better served to simply ease the accounting to reflect the longer term, cyclical nature of the asset and make sure the affected institutions have enough liquidity to ride out the cycle? Would liquidity require less of a fix than the capital to write down the assets?

I don't know the answer, but I'm curious what others here think.

 

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Maximum Peach



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  posted on 2/12/2009 at 03:35 PM
quote:
I watched nearly all of the House Financial Services hearings yesterday, kinda' part of my job. The stunning thing there was how gross ignorant most members of the committee were as to how the banking system actually works. You would think they or their staffs would have some expertise, or at least some fundamental knowledge of how the financial system and the credit markets work in order to be appointed to this committee.


Buppalo, I actually started another thread sort of about that...see the one about Kangaroo Court. Maxine Waters was the biggest offender. To be fair and to Greg's point, even if you work in this industry, there is no way to fully understand a lot of this stuff, but for crying out loud, if they are going to do whatever the hell they did yesterday (which was nothing but flogging these guys), they should at least educate themselves.

By the way, totally agree that they have to rip through this glut of inventory and get it into viable hands at whatever price.


quote:
Another casualty was the Retirement Systems of Alabama. The system lost 4% of its value due to exposure to Lehman bonds and preferreds.



And they weren't the only retirement system by any stretch that was caught holding the bag. Coincidentally enough, I was meeting with Dr. Bronner and his investment team the day Lehman collapsed. That is one day that will be burned into my mind forever, sort of felt like a 9/11 type event.

 

Universal Peach



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  posted on 2/12/2009 at 06:15 PM
quote:
Buppalo1 - a play out of a book that has worked before....but, the biggest criticism of that method is that it forces further writedowns as it becomes a fire sale/auction instead of an orderly sell out which would preserve value.

As we've discussed, especially as it pertains to real estate, these are long term assets and we're forcing valuations and sales at distressed prices, in some cases with no reason to force the issue. We'd also be forcing the sale of assets at a time when traditional lenders are not lending, making financing hard to come by, further distressing values (although rates couldn't be much lower, could they??)

Would we be better served to simply ease the accounting to reflect the longer term, cyclical nature of the asset and make sure the affected institutions have enough liquidity to ride out the cycle? Would liquidity require less of a fix than the capital to write down the assets?

I don't know the answer, but I'm curious what others here think.


Some good points here.
And what you're talking about of course, is "mark-to-market."
Trying to talk here in terms the lay person can understand....
Say you own a bond from a quality company. Say IBM. And it was issued in 1999 and matures in 2019. And pays 7% annual interest. It's been through several hands in the last 10 years and will pay its face value of $1000 at maturity in ten more years.

What is it worth? Well, with that nice interest rate and quality issuer, it would logically be worth a little more than face value--say, $1040. But meanwhile, in Boston, a hedge fund that holds some of these bonds is in desperate need for cash to meet redemption requests and needs to sell their bonds. And nobody is buying, because everybody is holding on to all the cash they got, because assets are hard to sell now.

So, what does the hedge fund do? It keeps cutting the price of its bonds until it finds a buyer. Maybe at $900.

Now, you're ABC bank, and you got $1M of these bonds, that are going to mature in 10 years at $1M. What are they worth? Because the last transaction that took place in them took place at $900 each, that's what they are ALL worth, according to "mark-to-market" accounting rules. Therefore, ABC bank has to take a paper loss of $100,000 and value thier bonds at $900,000. A loss to capital.

How does this apply to real estate? I'm not sure at all. How do you apply it to a sub-division? Obviously, if you auction an entire subdivision, the market has set the price.
Say it's 50 cents on the dollar. Does this make a sub-division in another part of the county worth 50 cents on the dollar? How about one in the next county over?

Tough questions. I sure don't know the answer. But it may affect why an institution doesn't want to do an absolute auction of an asset. It may cause a fatal devaluation of its capital base via mark to market.

Whatever these guys come up with--and by that, I mean the Fed, Fdic, and Treasury,
I will tend to support. They have a tough challenge. I hope input from Congress can be kept to a minimum.

 
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  posted on 2/12/2009 at 06:16 PM
Hey, Randy, glad you found out we do wear shoes over here sometime.

Y'all are speaking Greek to me, but your discussion gives me a better understanding of something I really don't have much knowledge about. I agree with those who say why not just pay off the mortgages, and let the people keep their houses, since it solves the problem all the way around. But it would be "rewarding failure," something we don't tolerate in this country.

It isn't very reassuring to hear y'all who know what you are talking about saying what you are about Congress. We're on a ship of fools.

 

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  posted on 2/12/2009 at 06:35 PM
Hell, I thought you THREW shoes, Brother.


 
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Maximum Peach



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  posted on 2/12/2009 at 10:46 PM
Anyone read Bill Gross from PIMCO? This is a great piece and he uses, actually his CIO uses, a great analogy to describe what is going on. I paraphrased it in another thread, but here is the whole piece. He gives a good simple explanation of what is going on. I would recommend even those not in finance reading him.

Here is the link too because I think there is a chart in the article, which I don't think came out when I pasted:

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2008/Investment+ Outlook+Gross+October+2008+Fear.htm

Investment Outlook
Bill Gross | October 2008

Nothing to Fear but McFear Itself



A Simple Explanation
We are to the point of fearing fear itself. America in all its resplendent free market capitalistic glory is on the auction block with few bidders. How this came to be is obvious in retrospect: too much exuberant leverage, not enough regulation; too strong a belief in asset-based prosperity, too little common sense that prices could go down as well as up; excessive “me first” greed, too little concern for the burden of future generations; a political morass unworthy of our Founding Fathers. You may have more to add to the list, but frankly there isn’t enough time. Historians can sit back and reflect, but at this very moment, America is for sale and there is fear and trembling in the auctioneer’s voice.

Average Americans know little of the ways of Wall Street nor will they ever, I suppose. Every day, these days, is on-the-job training for yours truly, so how could Jane or John Doe ever understand the complexities of overnight repos or reverses, the selling or buying of protection on corporations via Credit Default Swaps (CDS), or the reasons why some investment banks are saved while others are allowed to fail? They cannot. So let me put it simply. Credit markets are based on trust and when there is no trust, markets can freeze up. My Co-CIO Mohamed El-Erian has a great everyday example. Imagine yourself at the drive-thru ordering a Big Mac. At one window you order and pay, at the other – 20 feet ahead – you pick up your lunch. What if you thought that after paying at the first window, your 1000 calorie sandwich might not be waiting for you a few seconds later. You might not pay; business as usual might not take place. That is what is happening in the credit markets. They are frozen in “McFear.” After the failure of Lehman Brothers – an investment bank which took orders at one window, and promised to pay at another for trillions of dollars of those CDS, swaps, and other derivative “sandwiches” – institutional investors said that they’d prefer to stay at home and have peanut butter instead of risking their money ordering a Big Mac. And so their money goes into that figurative mattress instead of the register at McDonald’s, people are laid off, profits go down, bank loans become less available,
our economic center cannot hold.

A More Sophisticated Explanation
PIMCO’s Investment Committee to a man (no women yet) believes that capitalism is the best and most effective economic system ever devised, but it has a flaw: it is inherently unstable. Every economy, capitalist, socialist, or communist requires long-term capital assets to allow it to function: buildings, roads, factories, homes, all of which have expected lives of 30 years or more. A classic communist system would build these things and it would be done – no financing, no debt coming due, and no worries. Capitalism, however introduces an instability because it uses short-term profit maximization via the buying and selling of debt and equity that finance these same capital projects. Because capitalism has a dynamic of profit maximization at its core, companies and households take on more debt or less, issue more stock or less, and then trade these obligations amongst each other, creating the possibility of bubbles and bankruptcy, faux prosperity and instability.

It is during these periods of potential bankruptcy and accelerating instability, however, that capitalism becomes particularly vulnerable. Confidence is replaced by fear. Any economy requires a continual replenishment of buildings, roads, and yes homes in order to survive. But whereas an old-style communist government would simply budget them into their new 5-year plan and direct their people to build them, capitalism must accomplish the same task via prices, markets, and confidence that this invisible hand will lead to future profits. Take your home for instance. While housing prices for long periods of time in the 20th century didn’t go up or down much, it’s fair to say that you would be reluctant to buy a house (and your bank reluctant to lend you a mortgage) if you thought it was going to go down in price. Same thing when companies build factories and invest in research and development; profits and in turn higher prices are fundamental drivers of the capitalistic ethic.

A month ago when I spoke to a potential financial tsunami, it was not to bail out our position of already well protected Agency mortgage-backed bonds. It was to alert you and yes, policymakers, that this inherent instability in our capitalistic system was threatening to feed on itself first in the housing market and then spreading to financial institutions – banks, investment banks and insurance companies as the sale of assets in the process of delevering led to home foreclosures and then bankruptcies for weak institutions that held assets of all kinds. That was not, I think, an inaccurate assessment as recent events have proven. But importantly, because prices are going down in every asset class, the threat to future investment in long-term capital projects and the real economy becomes magnified. That doesn’t mean of course that capitalist investors must be guaranteed a profit. Far from it. But when prices in all asset categories decline by double-digits, well then Washington, London, Frankfurt, Tokyo, and Beijing – we have a problem. I reproduce last month’s asset price chart to accentuate my point.



Now, as recognition of a systemic period of capitalistic instability becomes apparent, the focus has legitimately shifted to a systemic solution. Much of the focus has been on U.S. policy and rightly so. It is here where the excesses of exuberance were most pronounced. But, up until the Treasury’s $850 billion rescue package, the policy responses may have been necessary and significant, but they were ad hoc and perhaps insufficient. A systemic delevering likely requires a systemic solution, which moves beyond cyclical interest rate cuts, liquidity provisions, or even the purchase of subprime mortgage-backed bonds. We believe that the Federal Reserve must now act as a clearing house, guaranteeing that institutional transactions clear (and investors receive) their Big Macs at the second window. They must also take another bold step: outright purchases of commercial paper. They should also cut interest rates to 1%, because we are experiencing asset deflation, and the threat of headline inflation is long past.

Whether these steps are successful depends in part on whether fear of fear itself has gone too far. They also depend on global coordination of policy because American-style capitalism is not just the bastion of America anymore. Almost all important economies have adopted it in one form or another and in doing so have assumed its inherent instabilities as well. Unlike the old days, however, policy responses are not dominated by the U.S. nor are they coordinated and identical. Some central banks have recently just finished raising interest rates (Brazil), while others have focused on tightening, not loosening liquidity (China). The net/net of all of this on a global-wide basis may not be as salutary as headlines indicate. And hopes for a unified global response may not be validated. Yesteryear’s supranational agencies centered on the IMF and World Bank cannot provide the solution nor have there been hints of a Plaza or Louvre Accord in the immediate future. Each economy appears to be pretty much on its own despite dollar swap arrangements and the like between Europe and U.S. central banks.






 

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  posted on 2/13/2009 at 10:28 AM
The key thing there is the date....October, 2008.

Gross and El-Arian are pretty brilliant guys. No political spin, just dealing with events on the ground as they see them. I don't always agree, but I always listen.

Much of what this article advocates has already happened....interest rates to 1% (or less),
using the FED as a clearinghouse, guaranteeing contra side. Amid much bashing by those who don't have a clue about all this, or a better idea.

Just thought I'd throw out a little more elaboration on Gregallmanfan's points.
One of the brokers in our office deals with some pretty high flyers. He's a Minyan, often on the set of Fast Money (not on camera), does quite a few trades for hedge funds, mutual funds.

One of his associates yesterday spent many millions buying a bundle of mortgages.
All performing, average FICO score 695. I guess that would probably be something like Alt-A? Anyway, you want to take a guess at what he paid for these performing mortgages?


Fourteen cents. Fourteen cents on the dollar.
That is how desperate some entities are for immediate cash. Liquidity.
They took 14 cents on the dollar for millions of dollars of PERFORMING mortgages.

So how does the Financial Accounting Standards Board or the FED or the SEC apply mark-to-market? Are all Alt-A mortgages now to be marked down to 14 cents on the dollar?
If you are CDE bank, in Peoria, been taking care of business, lending prudently to your area client base--do you now have to mark down a substantial portion of your PERFORMING loan portfolio by 86%? Report a huge loss to their sharholders and regulators? Perhaps even become insolvent on paper? Gotta' be a better way, IMHO.
And I'm not an accountant, so I may not be getting the mark-to-market controversy exactly right. This is how I understand it.

The mortgage transaction I described is real, not hypothetical.

 
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  posted on 2/13/2009 at 11:33 AM
Bupp, that lines up w/exactly what I'm hearing.

The impossible aspect of creating a market for the toxic/legacy assets is they're all so incredibly different...similiar to the fact they essentially every house is different. I've tried to explain it to clients in these terms: it's like the Gov't saying 'we're going to buy all of the Small Cap stocks...at $3'. That is ludicrous, and impossible. I feel the same about the concept of 'creating a market' in these assets- idealistically, great idea...but, literally, I see it is not possible.

Along w/your example above, I was told this story this week by another advisor. He quoted the former CFO of M Lynch, who said (I'm paraphrasing): "we had 1.4Trillion of mortgages...$950 Billion of which were current/paying...but we still had to write those $950B down to 50 cents on the dollar." That's just brutal. That's not 14 cents brutal, but still brutal, nonetheless.

Mark to market? Clearly the spirit behind it (transparency, Enron, Worldcom, etc) was noble and for the right reasons. I just don't think anyone envisioned this type of calamity. If they simply (I know it's not quite this simple) went to a cash-flow based valuation metric, I believe the market would get a hellacious short-term lift...and it would give the bank balance sheets a lifeline. I have read many who have stated if 'they' simply got rid of mark to market for X years....we could get through this w/less damage. And it wouldn't cost $800B, or whatever number is today. I know that would lead to some abuse but I do believe, in general, it would work and provide a floor for the housing/economy/bank sector/stock mkt.

We'll see. Keep your hard hats on...



[Edited on 2/13/2009 by Leon]

 

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  posted on 2/13/2009 at 11:46 AM
You know, it wasn't THAT long ago that FASB allowed firms to differentiate between securities held for sale and for longer term investment. Held for sale was marked to market, long term was valued at cost - provided it wasn't impaired - which in these times would probably suggest the cash flow valuation that Leon mentions.

It's just allowing the pendulum to swing back a bit after the Enrons etc.

 

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  posted on 2/13/2009 at 12:04 PM
quote:
Gross and El-Arian are pretty brilliant guys. No political spin, just dealing with events on the ground as they see them. I don't always agree, but I always listen.


I agree, I should have mentioned it was a dated piece. I just thought it was a good analogy of what led to the crisis for those who don't have financial backgrounds.

quote:
Just thought I'd throw out a little more elaboration on Gregallmanfan's points.
One of the brokers in our office deals with some pretty high flyers. He's a Minyan, often on the set of Fast Money (not on camera), does quite a few trades for hedge funds, mutual funds.

One of his associates yesterday spent many millions buying a bundle of mortgages.
All performing, average FICO score 695. I guess that would probably be something like Alt-A? Anyway, you want to take a guess at what he paid for these performing mortgages?



I work for an asset management firm that was started as a MBS fixed income specialist. The firm was founded by the man who many consider to be the pioneer of the MBS market. I work in marketing and client service, so as you can imagine, I have been shot a few times in the last 2 years regarding performance in our portfolios. My job has become increasingly difficult on the client service side explaining to my clients that the majority of the bonds we hold for them are performing mortgages when their market values are beaten to hell. In fact, I have to go down to GA next week to one of my clients who is invested in a CMBS and RMBS srategy that is down about 50%. Nearly all of the underlying loans in the bonds that we hold are performing, yet prices on some of the bonds are literally 8 cents on the dollar. We actually pride ourselves on doing very deep credit work, even getting loan level detail, before we make our purchases and it still didn't matter. In the eyes of the market, mortgage=bad. Incidentally, you may get a mark of 8 cents on the dollar but if you try to sell it right now, you will fetch even less, partcularly if it is a smaller size or odd lot.

Its very hard to convice someone they are holding performing bonds when they are getting prices on AA rated bonds (very safe investment, right?) that are in the 20 cents on the dollar range!! The market trades anything below AAA as virutally worthless. To prove a point, right now I am looking at the commerical mortgage backed returns in the Barclay's CMBS Investment Grade Index. Look at the bifurcation of returns for December (obviously dated, but I bet you will see something similar going forward). This might be a little jargony (duration, most CMBS bonds are 10 year bonds, hence the 8.5+ duration bucket) for those who don't work in finance, but for those who do, its pretty eye opening, watch what happens when you went down just one credit notch:

Monthly Price Return
AAA (8.5 duration): 22.67
AA (8.5 duration): 2.73
A (8.5 duration): 5.13
BBB (8.5 duration): Now this is the real kicker: -0.43

Its absurd quite frankly. Of course, for people with dry powder (cash), this is a phenomenal opportunity to invest (with risk based capital which can withstand volatility). You can buy the safest commercial mortgage backed security (what they call Super Duper AAA) for about 60 cents on the dollar with a 14% yield. As the kids say today, its stupid!!



 

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  posted on 2/13/2009 at 01:32 PM
Jim, that is eye opening, and the question begs....why?

Some of it is irrational, no doubt. But I have to wonder what part of that is due simply to people thinking defaults are going to skyrocket because the economy (jobs particularly) is so bad and going to get worse? Is the expected rate of default, and subsequent loss given default, that high?

 

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  posted on 2/13/2009 at 01:35 PM
quote:
Bupp, that lines up w/exactly what I'm hearing.

The impossible aspect of creating a market for the toxic/legacy assets is they're all so incredibly different...similiar to the fact they essentially every house is different. I've tried to explain it to clients in these terms: it's like the Gov't saying 'we're going to buy all of the Small Cap stocks...at $3'. That is ludicrous, and impossible. I feel the same about the concept of 'creating a market' in these assets- idealistically, great idea...but, literally, I see it is not possible.

Along w/your example above, I was told this story this week by another advisor. He quoted the former CFO of M Lynch, who said (I'm paraphrasing): "we had 1.4Trillion of mortgages...$950 Billion of which were current/paying...but we still had to write those $950B down to 50 cents on the dollar." That's just brutal. That's not 14 cents brutal, but still brutal, nonetheless.

Mark to market? Clearly the spirit behind it (transparency, Enron, Worldcom, etc) was noble and for the right reasons. I just don't think anyone envisioned this type of calamity. If they simply (I know it's not quite this simple) went to a cash-flow based valuation metric, I believe the market would get a hellacious short-term lift...and it would give the bank balance sheets a lifeline. I have read many who have stated if 'they' simply got rid of mark to market for X years....we could get through this w/less damage. And it wouldn't cost $800B, or whatever number is today. I know that would lead to some abuse but I do believe, in general, it would work and provide a floor for the housing/economy/bank sector/stock mkt.

We'll see. Keep your hard hats on...



[Edited on 2/13/2009 by Leon]
Spot on!!!

This is a great thread.

 

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This one goes to eleven...

 
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