For Stop the Bubble Hype from SD Realtor

[Allan from Fallbrook]

SD Realtor,

I was working as a CFO for a large Orange County insurance brokerage in 1994. At the time, the large investment houses, including Bear Stearns, Merrill Lynch and Lehman Bros, were making the rounds selling derivatives on margin. These were the same investment products that the Comptroller of Orange County had recently purchased, and they were being heavily touted throughout the Orange County institutional and commercial investment market as a result.

I sat through a presentation at our office in Tustin given by Merrill Lynch. My boss, the CEO, was an MBA (Ohio State) and a former Bear Stearns guy. I remember feeling somewhat embarrassed because I had no idea what the hell the Merrill guy was talking about, but figured that my boss did. Lo and behold, he was just as confused as I was. We both agreed that we shouldn’t invest in something neither of us understood. Shortly thereafter, Orange County went bankrupt due to a margin call on their derivatives position.

The point I am making is this: All of these CDO (collateralized debt obligations) and CDS (credit debt swap) products backing these mortgages (sub-prime and Alt.A) are part of a largely unregulated and little understood section of the market. I don’t think we (the general public) have clue one as to how bad the fallout could potentially be, but if Orange County in 1994 is any example, it could get real ugly.

Your comment on valuation was bang on the money. What Bear Stearns is facing in particular right now is the investor backlash surrounding misrepresented value (overstated) and risk (understated). Bear Stearns has a $20B position in the sub-prime market, and is absorbing losses at a frightful pace right now.

You did spell tranch correctly, btw.

Regards

[Allan from Fallbrook]

SD Realtor,

I was working as a CFO for a large Orange County insurance brokerage in 1994. At the time, the large investment houses, including Bear Stearns, Merrill Lynch and Lehman Bros, were making the rounds selling derivatives on margin. These were the same investment products that the Comptroller of Orange County had recently purchased, and they were being heavily touted throughout the Orange County institutional and commercial investment market as a result.

I sat through a presentation at our office in Tustin given by Merrill Lynch. My boss, the CEO, was an MBA (Ohio State) and a former Bear Stearns guy. I remember feeling somewhat embarrassed because I had no idea what the hell the Merrill guy was talking about, but figured that my boss did. Lo and behold, he was just as confused as I was. We both agreed that we shouldn’t invest in something neither of us understood. Shortly thereafter, Orange County went bankrupt due to a margin call on their derivatives position.

The point I am making is this: All of these CDO (collateralized debt obligations) and CDS (credit debt swap) products backing these mortgages (sub-prime and Alt.A) are part of a largely unregulated and little understood section of the market. I don’t think we (the general public) have clue one as to how bad the fallout could potentially be, but if Orange County in 1994 is any example, it could get real ugly.

Your comment on valuation was bang on the money. What Bear Stearns is facing in particular right now is the investor backlash surrounding misrepresented value (overstated) and risk (understated). Bear Stearns has a $20B position in the sub-prime market, and is absorbing losses at a frightful pace right now.

You did spell tranch correctly, btw.

Regards

[LA_Renter]

I just wanted to add a comment to this;

“That if the contents of each tranch (probably mispelled) within each fund were studied, the investors would find that they are really not holding what they thought they were holding.”

That fact that this is being discussed on blogs and chat boards all over the place pretty much indicates that the Jeanie is out of the bottle. I mean if I know that these subprime contents are trash then I would assume the major players also know this. A major re-pricing of these portfolios is inevitable at this point.

[LA_Renter]

I just wanted to add a comment to this;

“That if the contents of each tranch (probably mispelled) within each fund were studied, the investors would find that they are really not holding what they thought they were holding.”

That fact that this is being discussed on blogs and chat boards all over the place pretty much indicates that the Jeanie is out of the bottle. I mean if I know that these subprime contents are trash then I would assume the major players also know this. A major re-pricing of these portfolios is inevitable at this point.

[Allan from Fallbrook]

LA_Renter,

Yup, yup and yup.

[Allan from Fallbrook]

LA_Renter,

Yup, yup and yup.

[DaCounselor]

The subprime MBS debacle, if you care to dive into it, is just another example in a long history of examples of shady Wall St manuevering to the detriment of unwitting (and therefore somewhat culpable) investors. For anyone who is truly interested in a behind the scenes look, a great and easy to digest start would be Michael Lewis’ book “Liar’s Poker”. It is particularly relevant to the existing market as the book, in part, discusses the origins of the mortgage bond market. It is very entertaining and by no means a dry read.

The real problem with the CDO’s is that they are rarely traded and hard to value. Pick a number, any number. And now that BS’s creditors have seized what – a billion dollars’ worth? – after a margin call, you have the creditors trying to sell these assets that no one has any idea how much they are really worth. Not good. And where is the poor investor in the mix? Tied to a concrete block at the bottom of the Hudson because BS suspended redemptions. Excellent! I think a key question now is are the creditors going to come on full force or are they going to sit back and let BS try to work some shady magic?

The game being played is really nothing new. The only question is what effect will we see on the greater market and economy. Will it be like a mortgage bond-junk bond-S&L crisis or will it be more contained. I really don’t know but it’s going to be an interesting show.

Oh, and it’s “tranche”.

[DaCounselor]

The subprime MBS debacle, if you care to dive into it, is just another example in a long history of examples of shady Wall St manuevering to the detriment of unwitting (and therefore somewhat culpable) investors. For anyone who is truly interested in a behind the scenes look, a great and easy to digest start would be Michael Lewis’ book “Liar’s Poker”. It is particularly relevant to the existing market as the book, in part, discusses the origins of the mortgage bond market. It is very entertaining and by no means a dry read.

The real problem with the CDO’s is that they are rarely traded and hard to value. Pick a number, any number. And now that BS’s creditors have seized what – a billion dollars’ worth? – after a margin call, you have the creditors trying to sell these assets that no one has any idea how much they are really worth. Not good. And where is the poor investor in the mix? Tied to a concrete block at the bottom of the Hudson because BS suspended redemptions. Excellent! I think a key question now is are the creditors going to come on full force or are they going to sit back and let BS try to work some shady magic?

The game being played is really nothing new. The only question is what effect will we see on the greater market and economy. Will it be like a mortgage bond-junk bond-S&L crisis or will it be more contained. I really don’t know but it’s going to be an interesting show.

Oh, and it’s “tranche”.

[Anonymous]

I learned it as ‘tranche.’

Yep, times are getting tough for higher income folks, too;
Median household income of $110K, 86% white collar, 5 acre lots in gated communities, and the job market is getting tough:

http://www.chicagotribune.com/business/chi-sun_barringtonjul01,0,2295198.story?coll=chi-business-hed

Coming to La Jolla and RSF, too.

[Anonymous]

I learned it as ‘tranche.’

Yep, times are getting tough for higher income folks, too;
Median household income of $110K, 86% white collar, 5 acre lots in gated communities, and the job market is getting tough:

http://www.chicagotribune.com/business/chi-sun_barringtonjul01,0,2295198.story?coll=chi-business-hed

Coming to La Jolla and RSF, too.

[Allan from Fallbrook]

Da Counselor,

Another really good book (when it comes to financial market debacles) is Roger Lowenstein’s, “When Genius Failed” (subbed “The Rise and Fall of Long-Term Capital Management”).

There are some significant parallels between LTCM’s 1998 meltdown and the coming MBS CDO/CDS meltdown. As of late, I am reminded of a couple of great expressions. One from Las Vegas that goes: “There’s a sucker in every game and, if you can’t find him at the table, it’s probably you”, and the Wall Street adage, “Never panic. But if you do panic, panic first”.

Bear Stearns is doing their best to “take one for the team” in trying to keep the damage localized but, given the size of the MBS CDO/CDS market, it looks increasingly beyond their ability to control. If/when that happens, it will be a bloodbath, as investors scramble for the exits and dump these securities at fire sale prices.

Interestingly, this same phenomenom will probably occur in the housing market at some point if the number of REOs and price-slashed builder properties overwhelms a local market’s ability to absorb underpriced excess inventory.

You can spell “tranche” either way. I have viewed numerous prospecti using both spellings.

[Allan from Fallbrook]

Da Counselor,

Another really good book (when it comes to financial market debacles) is Roger Lowenstein’s, “When Genius Failed” (subbed “The Rise and Fall of Long-Term Capital Management”).

There are some significant parallels between LTCM’s 1998 meltdown and the coming MBS CDO/CDS meltdown. As of late, I am reminded of a couple of great expressions. One from Las Vegas that goes: “There’s a sucker in every game and, if you can’t find him at the table, it’s probably you”, and the Wall Street adage, “Never panic. But if you do panic, panic first”.

Bear Stearns is doing their best to “take one for the team” in trying to keep the damage localized but, given the size of the MBS CDO/CDS market, it looks increasingly beyond their ability to control. If/when that happens, it will be a bloodbath, as investors scramble for the exits and dump these securities at fire sale prices.

Interestingly, this same phenomenom will probably occur in the housing market at some point if the number of REOs and price-slashed builder properties overwhelms a local market’s ability to absorb underpriced excess inventory.

You can spell “tranche” either way. I have viewed numerous prospecti using both spellings.

[Allan from Fallbrook]

Speaking of Bear Stearns, I came across this article on Bloomberg about them trying to sell “Toxic Waste” CDOs to CalPERS and other pension funds. They are hawking these products as being safe, and they are offering a 20% return.

Da Counselor’s comment above used the term “shady” to describe certain Wall Street deals, and I cannot think of a better term. Well, unless you skip “unethical”, “loathsome”, and “contemptible”, that is.

http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aW5vEJn3LpVw

[Allan from Fallbrook]

Speaking of Bear Stearns, I came across this article on Bloomberg about them trying to sell “Toxic Waste” CDOs to CalPERS and other pension funds. They are hawking these products as being safe, and they are offering a 20% return.

Da Counselor’s comment above used the term “shady” to describe certain Wall Street deals, and I cannot think of a better term. Well, unless you skip “unethical”, “loathsome”, and “contemptible”, that is.

http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=aW5vEJn3LpVw

[Anonymous]

Aw, Allan, you mean the same ‘prospecti’ that lay out overstated values for CDOs and the like?

I’ve not seen ‘tranch’ before in regard to finance (only in regard to sturgeon slicing). But, I’m willing to learn; show me a definitive source, sir!

[Author]

Posts