Phorgy Phynance

Archive for the ‘Mortgages’ Category

The word is out… it’s NOT about subprime

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Whenever I read about “subprime contagion”, I feel frustrated. When you get the flu, does the runny nose cause the muscle aches? No. Just because the runny nose came first doesn’t mean the flu can be described as “runny nose contagion”. The subprime mess was just the first symptom to appear in the bursting of a general credit bubble. The corporate high yield market saw very similar aggressive loan covenants. Commercial real estate. Emerging markets. You name it. We’ve been in the midst of a general fixed-income bubble since our friends at the Fed decided to keep rates far too low for far too long.

Think about this. Back in 2005, we were worried about the CDS market reaching $17 TRILLION notional. That is a HUGE number. But the notional amount is not indicative of overall exposure because of hedging, right?

If you want to see a perfect hedge, visit a Zen garden.

What is that number today? More like $45 TRILLION. That is insane. An entire new insurance industry has basically assumed that corporate defaults do not exist anymore. Not only that, a “hedge” can turn into naked exposure at the flip of a switch, i.e. what happens when the entity you bought insurance from no longer exists?

When I get a chance, I hope to start posting some more mathematical analysis of what’s going on (since that’s what I’m good at). For example, a primer on Leverage Mathematics 101 (which is partially complete) followed by Hedge Mathematics 101 would be a good start. In risk management, “hedging” basically means “let’s buy(sell) some similar securities so that we have more capital to buy other stuff.” In other words, hedging allows you to leverage yourself more.

Here is an article that may help spread the word, i.e. it’s not about subprime:

Straight Talk on the Mortgage Mess from an Insider

However, I would go even further. The truth is the current mess is not even about mortgages. Here is the word we should all be thinking about, “Fixed Income Bubble”.


Written by Eric

December 9, 2007 at 10:16 pm

“Calculated Risk” telling it like it is

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This is a fantastic article by one of my favorite bloggers.

SFAS 140: Like A Bridge Over Troubled Bong Water

The issue of FAS 140 and whether QSPE’s should be on or off balance sheet aside, these paragraphs resonated soundly with the way I think about the mortgage issue:

The time to have gotten fired up about the real issues around off balance sheet securitization–the great “de-linking” of risk that was openly advertised as the benefit to the investor of all of this–was back when those 2/28s were being originated. We here at Calculated Risk were on it back then, and being dismissed as “bubbleheads.” Absolutely nobody, as far as I know, is happy with any of the bad choices we now have since we’ve gone into cleanup mode. But this desperate attempt to keep the moral hazard in place, whether it’s Cramer begging for a rate cut or bond investors demanding that FASB shoot the wounded, sink the lifeboats, and close the gates of mercy to protect the interests of the AAA crowd, is a little hard to take.

Sit down, boys and girls. There has always been an “information asymmetry” issue with mortgage-backeds. The originator has always known more than you know. The servicer has always known more than you know. The auditors have always known more about the balance sheet ingredients than you have. This problem did not arise a couple of months ago when the ABX tanked.

It has also always been the case that the party on the other side of that cash-flow is Joe and Jane Homeowner. Taxpayer, voter, citizen, parent, child, grannie and gramps, your neighbor. This is a group of folks it’s a bit hard to demonize. We’ve been trying, with this “it’s all subprime and all subprime borrowers are deadbeats” meme, but except for a few dead-ender holdouts, that dog is no longer barking. No one will be less surprised than I to find many politicians doing the wrong thing here, out of a misguided sense that something must be done, and seen to be done. Possibly someone will do something sane and useful.

But if you are surprised that this is now, fully and inescapably, a political issue, and it’s homeowners against Wall Street, then you never realized that it’s about mortgages. After Social Security, this is the closest thing to a Third Rail that there is. They call it the “American Dream” for a reason. If you thought this was just a socially-neutral “asset class” you could simply suck dry forever, a little wind-up toy that would never fight back, you’re Part. Of. The. Problem. And I for one raise my mechanical pencil, as lama says, in salute to all the nerds at FASB who are ignoring you.

A-%#$%ing-men brother. When I started life in asset management in July 2005, I was looking to purchase my own house and was offered some whacky mortgages that I knew I couldn’t afford. Basic human nature told me that most would succumb to the temptation,

I can buy THAT?!?! [*looking at a beautiful brand new 2-story single family home*]

When I voiced my concerns about the housing market, I was told that it was no big deal because housing constituted less than 3% or whatever it was of the GDP. WTP?!?! [to understand that acronym, think “NuclearPhynance”] They had even computed that major resets would hit in 2007-2008 and if all defaulted it would have only a minor impact on the overall economy. My response was,

What about the political fall out? You can’t kick tens of thousands of people out of their homes without major political unrest. Maybe even riots.

We haven’t seen riots yet, but I wouldn’t be surprised if it comes to that before this mess is over.

Calculated Risk, thank you for telling it like it is.

Written by Eric

August 6, 2007 at 9:46 pm