The Big Question

[JayB]

Um...bullshit.

 

The mortgage backed securities are practically worthless because they contain too many defaulted loans, which, after all, is why the investment banks are failing.

 

Firstly this is just wrong. Investment banks (or those banks formerly known as investment banks), are defaulting because they can't borrow. They can't borrow because nobody knows the value of their balance sheet.

 

Secondly, calling mortgage backed securities "practically worthless" is a strech. How many people that you know are currently in forclusure? Lets assume that 10% of people with mortgages are in or will be in forclosure (this number is ridiculously high). We'll also assume that a house in forclosure is absolutly worthless (not true). What is the value of the mortagage backed securities backing these houses? 90%.

 

The problem is nobody knows who will be forclosed upon. It could be that in a given bond 90% of the houses in it are being forclosed upon. But you can't really know this. So nodoby will buy them. The number I heard, and I could be totally wrong, is that mortgage backed securities right now are selling for 22 cents on the dollar. Do you reall believe the value of the US housing market is down 78% in the last 2 years?

 

I have no idea how to value a securitized bundle of mortgages that's been through the tranche-making ginsu machine, but I suspect that they're trying to put a dollar value some combination of the value of the underlying collateral and the stream of payments that the loans taken out to purchase the said collateral are worth.

 

Given that the securitized bundles were divided into pyramids, with the tranches on the bottom eating all (or the vast majority) of the losses first, and the "super-senior" tranches at the top being relatively insulated from losses - this is probably more difficult than it would seem at first glance. I suspect that in the case of the tranches at the bottom of the pyramid, losses of 10-20% in the larger portfolio that they're part of will render them completely worthless, even if the land + structure + stream of payments that were chopped up and packaged into them have some kind of residual value well north of zero.

 

If you scour through Calculated Risk postings or some Wikipedia entry on RMBS valuation, you might get some information from someone who knows how all of this actualy works.

[dberdinka]

The mortgage backed securities are practically worthless because they contain too many defaulted loans...

 

Worthless? Aren't the properties still there as collateral? If that is the case, even with dropping housing prices, there is still a real asset represented by those securities right? House prices have dropped at most ~40% in places like Florida/Vegas/Phoenix, but that means that 60% of the value of those assets is still real and attainable. Right?

 

Please correct me if I'm wrong.

 

 

My understanding is that...

 

Each mortgage security was subdivided into pieces that were then sold. They are arranged in seniority as to how they get paid out. Those that pay out first are less risky and hence have a lower rate of return, those that get paid out last have higher risk and hence are given a higher return. If you get enough forclosures in the pool of mortgages the security is based on some of these pieces are going to receive very little in payout.

 

They also created CDOs based on these mortgages. The only expanation you'll ever see for them is that no one understands them. As far as I can tell each CDO is an insurance contract of some sort that were used to bet on the rate of return of the underlying security. So there is no underlying asset on these things and evidently many of them aren't worth crap.

 

 

 

[dberdinka]

Given that the securitized bundles were divided into pyramids, with the tranches on the bottom eating all (or the vast majority) of the losses first, and the "super-senior" tranches at the top being relatively insulated from losses -

 

I have read (I think on CR) that the investment banks held onto the "Super-senior" tranches and sold off all the "bottom" tranches as investments. The fact that the banks are now struggling with the value of the very best part of the securities implies the investors of the world absolutely lost their shirts. Bailout or not no ones going to be trusting the US Financial Industry anytime soon.

Edited September 25, 2008 by dberdinka

[mattp]

It looks like they listened to TVash. It looks as if they'll commit to just a few billion at a time:

 

Wall Street Journal

 

Earlier in the day, after a three-hour meeting, lawmakers agreed to legislative principles that would approve Treasury's request for the funds, but would break it into installments. Treasury would have access to $250 billion immediately, with another $100 billion to follow if needed. Congress would be able to block the last installment through a vote if it was unhappy with the program.

 

And they are retaining some oversight:

 

Other parts of the agreement include: a new oversight board that would have the ability to issue "cease and desist" orders over the program

 

Stir in a little populism, and we have a deal!

[Gary_Yngve]

Oh, and eerily, half of Americans are against a bail out plan...just like the invasion of Iraq.

 

Can we get the Confederacy together again? I think Washington needs a little burnin' right about now.

 

The funny thing is the split isn't really partisan. Many repubs are POed about it.

[tvashtarkatena]

Um...bullshit.

 

The mortgage backed securities are practically worthless because they contain too many defaulted loans, which, after all, is why the investment banks are failing.

 

Firstly this is just wrong. Investment banks (or those banks formerly known as investment banks), are defaulting because they can't borrow. They can't borrow because nobody knows the value of their balance sheet.

 

Secondly, calling mortgage backed securities "practically worthless" is a strech. How many people that you know are currently in forclusure? Lets assume that 10% of people with mortgages are in or will be in forclosure (this number is ridiculously high). We'll also assume that a house in forclosure is absolutly worthless (not true). What is the value of the mortagage backed securities backing these houses? 90%.

 

The problem is nobody knows who will be forclosed upon. It could be that in a given bond 90% of the houses in it are being forclosed upon. But you can't really know this. So nodoby will buy them. The number I heard, and I could be totally wrong, is that mortgage backed securities right now are selling for 22 cents on the dollar. Do you reall believe the value of the US housing market is down 78% in the last 2 years?

 

And why is the value of these securities not known? Because of uncertainty due to a high default rate (and the uncertainty of real estate values in general). Badumpbump.

 

Second, practically worthless is a relative term. Would your rather invest in risky securities that could lose 10, 20, or 30 % of their value, or invest in something else? Personally, I object to the Federal government forcing me to invest in the former.

 

Foreclosures are money losers. Big money losers. Bankrupcy protects the original loanees from paying out. Legal processes eat up more money and manpower. And, many times, the properties themselves are not the most salable or desireable. Auctions, necessary to save time and effort, generally yield only firesale prices. Securities backs by such foreclosure prone loans, particularly in an era of long term decline of real estate values, are therefore losers.

 

Finally, you speak as though a high foreclosure rate 'might' happen. Um...it has been happening. After all, it's the root of this mess.

 

Aside from not successfully countering my original points, you also have not told us why such a bail out is a good idea at all, or why, in fact, it isn't the worst thing we could do with $700 billion we, cough, actually don't even have right now.

 

What needs to happen is that real estate values need to fall to where they need to, and the economy needs to slow to where it needs to for things to level out.

Edited September 25, 2008 by tvashtarkatena

[JayB]

Given that the securitized bundles were divided into pyramids, with the tranches on the bottom eating all (or the vast majority) of the losses first, and the "super-senior" tranches at the top being relatively insulated from losses -

 

I have read (I think on CR) that the investment banks held onto the "Super-senior" tranches and sold off all the "bottom" tranches as investments. The fact that the banks are now struggling with the value of the very best part of the securities implies the investors of the world absolutely lost their shirts. Bailout or not no ones going to be trusting the US Financial Industry anytime soon.

 

Garbage-in, Garbage out I suppose. Given that the appraisal of the underlying collateral was probably submitted by a guy who had incentives to "hit the number" necessary for the loan to go through, the information on the mortgage application was probably incomplete or fraudulent even on a high percentage of "PRIME" loans, I'm not surprised to learn that the super-senior stuff is also rife with losses.

 

I'm not sure how the folks in the rest of the world financed their respective bubbles (priced a Condo in Vancouver, lately?), but from what I've seen their valuations were just as baroque as those in the US, if not more so. Even if there systems were also jacked up, I think you're right that we're (Americans) all going to be paying more to borrow from the rest of the world for quite a while.

[Hugh Conway]

I have no idea how to value a securitized bundle of mortgages that's been through the tranche-making ginsu machine, but I suspect that they're trying to put a dollar value some combination of the value of the underlying collateral and the stream of payments that the loans taken out to purchase the said collateral are worth.

 

Given that the securitized bundles were divided into pyramids, with the tranches on the bottom eating all (or the vast majority) of the losses first, and the "super-senior" tranches at the top being relatively insulated from losses - this is probably more difficult than it would seem at first glance. I suspect that in the case of the tranches at the bottom of the pyramid, losses of 10-20% in the larger portfolio that they're part of will render them completely worthless, even if the land + structure + stream of payments that were chopped up and packaged into them have some kind of residual value well north of zero.

 

If you scour through Calculated Risk postings or some Wikipedia entry on RMBS valuation, you might get some information from someone who knows how all of this actualy works.

 

There's a ton of academic papers out there on various valuation models for both CDOs and CDSs

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=296402

is a start. What they actually use in industry I don't know, but I have a feeling such models are tightly guarded proprietary information.

 

And here's an interesting run through of an actual Alt-A fund:

http://www.nytimes.com/2008/09/25/business/25value.html

[prole]

How psyched are Americans going to be to find out the hard way about all the bankruptcy "reform" that's been going on under their noses at the same that financial deregulation was taking place?