This is a really interesting development. A couple of issues/observations:
(1) If all of the institutions involved (and others more indirectly involved in this rolling disaster) had to mark these positions to observed market values there would be a MAJOR fiasco. Otherwise, they wouldn’t be going through all of these machinations and pledging all of this capital TO AVOID THE REAL ISSUE: PRICE DISCOVERY. This is an admission of huge underlying problems.
(2) The assumption behind the establishment of this “super fund” (this description is so rich in unintentional irony I can hardly stand it) is that current market values for this sludge are not a true reflection of economic values. In other words, the issue is liquidity rather than these securities’ true cash flows. This may or may not be the case. No one knows the answer here. It would take a team of knowledgeable professionals weeks to analyze just a handful of these securities properly, which would involve all sorts of Monte Carlo simulations regarding default rates, prepayment rates, etc. Bottom line: Even the institutions that own this crap don’t really know what it’s worth. This super fund is all about buying time in the hope that things will improve. From these institutions’ standpoint there’s no downside to delaying price discovery. Who knows… maybe the securities will ultimately be worth more than their current market values. And if they’re not, then they’re sunk anyway. So why not delay things?
(3)It will be fascinating to see how the market reacts to this news. The bears will say, “A ha! There are major problems out there that haven’t been acknowledged to the public. Stocks should go down.” But the bulls will say, “Party on, dudes! It’s all under control. The institutions are going to form a totally rad super fund that will make these pesky liquidity issues go away. Buuuuuuuuyyyyyyyyy, Winthorpe, Buuuuuuuyyyyyyyy!!” I have no clue who wins this tug of war.
(4) I suspect that things are much worse than the large institutions are letting on. The real problem – the one that won’t go away merely by delaying price discovery – is that these securities are backed by mortgages that a lot of people aren’t paying on, and the collateral values are plummeting. And the situation is getting worse and will continue to get worse for at least a couple of years. Nothing – and specifically not this super fund – will change this fact. As I like to say when discussing this issue with colleagues: “The loans have been made. You can’t put the genie back in the bottle. In the short term it’s about perception. But in the long term these are just a whole boatload of really ugly mortgages and securities. And nothing will change that fact.”
In summary: This reeks of rearranging the deck chairs in the hopes that a big whale will come along and plug the hole in the ship until help arrives. The problem is that, ultimately, I don’t think help arrives for most of these securities. The loans have already been made…
