On Price, Intrinsic Value, MBS, and Mark-to-Market

[CA renter]

davelj wrote:

I didn’t accuse YOU of plagiarism. I was responding to ARRAYA’s post (as you can see)! (Unless you and arraya are the same person, that is… which would beg a whole host of questions.) You’re clearly confused. What planet are you on?

================================
Because arraya was quoting me. The first paragraph you were referring to was written by me, soley by me, using only my words. Assuming you were referring to this quote:

And therein lies the problem with leverage…it relies on ever-expanding leverage and debt.

At what point do we decide to actually make good on all our debts and bets? Is this not **exactly** what a Ponzi scheme is? Has there ever been a Ponzi scheme that didn’t implode when its upper-most limits were reached? Do we believe in “infinite upper limits,” and how would that work?
===========================

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[davelj]

[quote=CA renter]davelj wrote:

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[/quote]

Ok, there was some confusion. I think we’re on the same page now. No biggie.

[davelj]

[quote=CA renter]davelj wrote:

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[/quote]

Ok, there was some confusion. I think we’re on the same page now. No biggie.

[davelj]

[quote=CA renter]davelj wrote:

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[/quote]

Ok, there was some confusion. I think we’re on the same page now. No biggie.

[davelj]

[quote=CA renter]davelj wrote:

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[/quote]

Ok, there was some confusion. I think we’re on the same page now. No biggie.

[davelj]

[quote=CA renter]davelj wrote:

That entire quote was entirely mine. I understand how it got confusing because we were all quoting one another, so apologize if it wasn’t meant as a personal slam, but if there’s anything I don’t do, it’s lie or cheat. I just took that very personally.

[/quote]

Ok, there was some confusion. I think we’re on the same page now. No biggie.

[davelj]

[quote=TheBreeze] Further, bank runs haven’t really been a problem (except for maybe at Indymac?). The problem was that the bigger financial institutions borrowed short, lent long, and, when one day they weren’t able to roll over their short-term financing, they were toast.

In your original post in this thread, you said this:

[quote=davelj]
Now, let’s assume for the sake of the argument that these AAAs are mispriced (that is, too low). The question is: Why? The answer is simple: Liquidity.
[/quote]

Well, I don’t think the answer is so simple. How do you value an asset when the collateral underlying that asset is decreasing in value at the rate of 4% a month? Liquidity may be part of the problem, but the fact that the value of the underlying collateral is suspect (as well as the future income streams) makes these assets very hard to value.

You also said:

[quote=davelj]
In this environment, illiquidity trades at an enormous discount. Many professionals I know and trust are as highly confident as they’ve ever been that some of these MBS represent the best risk-to-reward they’ve ever seen, but outside of their personal accounts they don’t have the proper (long-term) vehicle to buy and hold the securities. So the selling continues, the prices decline, and there’s not enough long-term capital out there to reverse things. The old negative feedback loop.
[/quote]

May be the selling is continuing because the value of the underlying collateral is continuing to decline?

That being said, you haven’t convinced this layperson that lack of liquidity or the banks having to engage in fire sales is the reason why the MBSs/CDOs/etc are continuing to decline in price.[/quote]

In order:

Bank runs have been the problem. Whether depositors are skittish and removing funds, or short-term lenders refuse to renew lines, the effect is the same: short-term liquidity disappears. In both cases it’s a run on liquidity.

All banks borrow short and lend long to varying degrees. This isn’t really the problem, per se. It’s how you go about matching your assets and liabilities. There are lots of ways of structuring a balance sheet through interest rate swaps and funding terms that can effectively leave a balance sheet “flat” (or match funded). But you have to want to do that. And you generally have to give up some profits (in the form of spread income) as well in exchange for reducing your exposure to interest rate risk. The problem (among others) with the bigger banks that have run into problems is that too much of their funding was “non-core” funding that required being rolled over, as opposed to “core” deposit funding, which is more stable. I have a general distrust of the funding structure of large banks – not enough core deposits to fund their lending and investing activities.

You asked how you value an asset when it’s value is falling X% per month. The market is forward looking. The bank doesn’t sit down and say, “Well, this MBS is worth X because the value of the underlying collateral has fallen Y% so far.” Instead they make assumptions about further falls in the value of the underlying collateral to come up with a value. And this is what folks buying various tranches of MBS in the market are doing now. They’re making assumptions about how bad things will be in the future in order to come up with a price they’re willing to pay today. In many cases, things will turn out worse than what’s imputed into the current price. And in some cases, things will likely turn out better. It’s going to vary by security.

If I haven’t convinced you of anything, that’s ok. That’s what makes a market, after all. If everyone agreed on the future, there would be no need to open up the exchanges each day.

[davelj]

[quote=TheBreeze] Further, bank runs haven’t really been a problem (except for maybe at Indymac?). The problem was that the bigger financial institutions borrowed short, lent long, and, when one day they weren’t able to roll over their short-term financing, they were toast.

In your original post in this thread, you said this:

[quote=davelj]
Now, let’s assume for the sake of the argument that these AAAs are mispriced (that is, too low). The question is: Why? The answer is simple: Liquidity.
[/quote]

Well, I don’t think the answer is so simple. How do you value an asset when the collateral underlying that asset is decreasing in value at the rate of 4% a month? Liquidity may be part of the problem, but the fact that the value of the underlying collateral is suspect (as well as the future income streams) makes these assets very hard to value.

You also said:

[quote=davelj]
In this environment, illiquidity trades at an enormous discount. Many professionals I know and trust are as highly confident as they’ve ever been that some of these MBS represent the best risk-to-reward they’ve ever seen, but outside of their personal accounts they don’t have the proper (long-term) vehicle to buy and hold the securities. So the selling continues, the prices decline, and there’s not enough long-term capital out there to reverse things. The old negative feedback loop.
[/quote]

May be the selling is continuing because the value of the underlying collateral is continuing to decline?

That being said, you haven’t convinced this layperson that lack of liquidity or the banks having to engage in fire sales is the reason why the MBSs/CDOs/etc are continuing to decline in price.[/quote]

In order:

Bank runs have been the problem. Whether depositors are skittish and removing funds, or short-term lenders refuse to renew lines, the effect is the same: short-term liquidity disappears. In both cases it’s a run on liquidity.

All banks borrow short and lend long to varying degrees. This isn’t really the problem, per se. It’s how you go about matching your assets and liabilities. There are lots of ways of structuring a balance sheet through interest rate swaps and funding terms that can effectively leave a balance sheet “flat” (or match funded). But you have to want to do that. And you generally have to give up some profits (in the form of spread income) as well in exchange for reducing your exposure to interest rate risk. The problem (among others) with the bigger banks that have run into problems is that too much of their funding was “non-core” funding that required being rolled over, as opposed to “core” deposit funding, which is more stable. I have a general distrust of the funding structure of large banks – not enough core deposits to fund their lending and investing activities.

You asked how you value an asset when it’s value is falling X% per month. The market is forward looking. The bank doesn’t sit down and say, “Well, this MBS is worth X because the value of the underlying collateral has fallen Y% so far.” Instead they make assumptions about further falls in the value of the underlying collateral to come up with a value. And this is what folks buying various tranches of MBS in the market are doing now. They’re making assumptions about how bad things will be in the future in order to come up with a price they’re willing to pay today. In many cases, things will turn out worse than what’s imputed into the current price. And in some cases, things will likely turn out better. It’s going to vary by security.

If I haven’t convinced you of anything, that’s ok. That’s what makes a market, after all. If everyone agreed on the future, there would be no need to open up the exchanges each day.

[davelj]

[quote=TheBreeze] Further, bank runs haven’t really been a problem (except for maybe at Indymac?). The problem was that the bigger financial institutions borrowed short, lent long, and, when one day they weren’t able to roll over their short-term financing, they were toast.

In your original post in this thread, you said this:

[quote=davelj]
Now, let’s assume for the sake of the argument that these AAAs are mispriced (that is, too low). The question is: Why? The answer is simple: Liquidity.
[/quote]

Well, I don’t think the answer is so simple. How do you value an asset when the collateral underlying that asset is decreasing in value at the rate of 4% a month? Liquidity may be part of the problem, but the fact that the value of the underlying collateral is suspect (as well as the future income streams) makes these assets very hard to value.

You also said:

[quote=davelj]
In this environment, illiquidity trades at an enormous discount. Many professionals I know and trust are as highly confident as they’ve ever been that some of these MBS represent the best risk-to-reward they’ve ever seen, but outside of their personal accounts they don’t have the proper (long-term) vehicle to buy and hold the securities. So the selling continues, the prices decline, and there’s not enough long-term capital out there to reverse things. The old negative feedback loop.
[/quote]

May be the selling is continuing because the value of the underlying collateral is continuing to decline?

That being said, you haven’t convinced this layperson that lack of liquidity or the banks having to engage in fire sales is the reason why the MBSs/CDOs/etc are continuing to decline in price.[/quote]

In order:

Bank runs have been the problem. Whether depositors are skittish and removing funds, or short-term lenders refuse to renew lines, the effect is the same: short-term liquidity disappears. In both cases it’s a run on liquidity.

All banks borrow short and lend long to varying degrees. This isn’t really the problem, per se. It’s how you go about matching your assets and liabilities. There are lots of ways of structuring a balance sheet through interest rate swaps and funding terms that can effectively leave a balance sheet “flat” (or match funded). But you have to want to do that. And you generally have to give up some profits (in the form of spread income) as well in exchange for reducing your exposure to interest rate risk. The problem (among others) with the bigger banks that have run into problems is that too much of their funding was “non-core” funding that required being rolled over, as opposed to “core” deposit funding, which is more stable. I have a general distrust of the funding structure of large banks – not enough core deposits to fund their lending and investing activities.

You asked how you value an asset when it’s value is falling X% per month. The market is forward looking. The bank doesn’t sit down and say, “Well, this MBS is worth X because the value of the underlying collateral has fallen Y% so far.” Instead they make assumptions about further falls in the value of the underlying collateral to come up with a value. And this is what folks buying various tranches of MBS in the market are doing now. They’re making assumptions about how bad things will be in the future in order to come up with a price they’re willing to pay today. In many cases, things will turn out worse than what’s imputed into the current price. And in some cases, things will likely turn out better. It’s going to vary by security.

If I haven’t convinced you of anything, that’s ok. That’s what makes a market, after all. If everyone agreed on the future, there would be no need to open up the exchanges each day.

[davelj]

[quote=TheBreeze] Further, bank runs haven’t really been a problem (except for maybe at Indymac?). The problem was that the bigger financial institutions borrowed short, lent long, and, when one day they weren’t able to roll over their short-term financing, they were toast.

In your original post in this thread, you said this:

[quote=davelj]
Now, let’s assume for the sake of the argument that these AAAs are mispriced (that is, too low). The question is: Why? The answer is simple: Liquidity.
[/quote]

Well, I don’t think the answer is so simple. How do you value an asset when the collateral underlying that asset is decreasing in value at the rate of 4% a month? Liquidity may be part of the problem, but the fact that the value of the underlying collateral is suspect (as well as the future income streams) makes these assets very hard to value.

You also said:

[quote=davelj]
In this environment, illiquidity trades at an enormous discount. Many professionals I know and trust are as highly confident as they’ve ever been that some of these MBS represent the best risk-to-reward they’ve ever seen, but outside of their personal accounts they don’t have the proper (long-term) vehicle to buy and hold the securities. So the selling continues, the prices decline, and there’s not enough long-term capital out there to reverse things. The old negative feedback loop.
[/quote]

May be the selling is continuing because the value of the underlying collateral is continuing to decline?

That being said, you haven’t convinced this layperson that lack of liquidity or the banks having to engage in fire sales is the reason why the MBSs/CDOs/etc are continuing to decline in price.[/quote]

In order:

Bank runs have been the problem. Whether depositors are skittish and removing funds, or short-term lenders refuse to renew lines, the effect is the same: short-term liquidity disappears. In both cases it’s a run on liquidity.

All banks borrow short and lend long to varying degrees. This isn’t really the problem, per se. It’s how you go about matching your assets and liabilities. There are lots of ways of structuring a balance sheet through interest rate swaps and funding terms that can effectively leave a balance sheet “flat” (or match funded). But you have to want to do that. And you generally have to give up some profits (in the form of spread income) as well in exchange for reducing your exposure to interest rate risk. The problem (among others) with the bigger banks that have run into problems is that too much of their funding was “non-core” funding that required being rolled over, as opposed to “core” deposit funding, which is more stable. I have a general distrust of the funding structure of large banks – not enough core deposits to fund their lending and investing activities.

You asked how you value an asset when it’s value is falling X% per month. The market is forward looking. The bank doesn’t sit down and say, “Well, this MBS is worth X because the value of the underlying collateral has fallen Y% so far.” Instead they make assumptions about further falls in the value of the underlying collateral to come up with a value. And this is what folks buying various tranches of MBS in the market are doing now. They’re making assumptions about how bad things will be in the future in order to come up with a price they’re willing to pay today. In many cases, things will turn out worse than what’s imputed into the current price. And in some cases, things will likely turn out better. It’s going to vary by security.

If I haven’t convinced you of anything, that’s ok. That’s what makes a market, after all. If everyone agreed on the future, there would be no need to open up the exchanges each day.

[davelj]

[quote=TheBreeze] Further, bank runs haven’t really been a problem (except for maybe at Indymac?). The problem was that the bigger financial institutions borrowed short, lent long, and, when one day they weren’t able to roll over their short-term financing, they were toast.

In your original post in this thread, you said this:

[quote=davelj]
Now, let’s assume for the sake of the argument that these AAAs are mispriced (that is, too low). The question is: Why? The answer is simple: Liquidity.
[/quote]

Well, I don’t think the answer is so simple. How do you value an asset when the collateral underlying that asset is decreasing in value at the rate of 4% a month? Liquidity may be part of the problem, but the fact that the value of the underlying collateral is suspect (as well as the future income streams) makes these assets very hard to value.

You also said:

[quote=davelj]
In this environment, illiquidity trades at an enormous discount. Many professionals I know and trust are as highly confident as they’ve ever been that some of these MBS represent the best risk-to-reward they’ve ever seen, but outside of their personal accounts they don’t have the proper (long-term) vehicle to buy and hold the securities. So the selling continues, the prices decline, and there’s not enough long-term capital out there to reverse things. The old negative feedback loop.
[/quote]

May be the selling is continuing because the value of the underlying collateral is continuing to decline?

That being said, you haven’t convinced this layperson that lack of liquidity or the banks having to engage in fire sales is the reason why the MBSs/CDOs/etc are continuing to decline in price.[/quote]

In order:

Bank runs have been the problem. Whether depositors are skittish and removing funds, or short-term lenders refuse to renew lines, the effect is the same: short-term liquidity disappears. In both cases it’s a run on liquidity.

All banks borrow short and lend long to varying degrees. This isn’t really the problem, per se. It’s how you go about matching your assets and liabilities. There are lots of ways of structuring a balance sheet through interest rate swaps and funding terms that can effectively leave a balance sheet “flat” (or match funded). But you have to want to do that. And you generally have to give up some profits (in the form of spread income) as well in exchange for reducing your exposure to interest rate risk. The problem (among others) with the bigger banks that have run into problems is that too much of their funding was “non-core” funding that required being rolled over, as opposed to “core” deposit funding, which is more stable. I have a general distrust of the funding structure of large banks – not enough core deposits to fund their lending and investing activities.

You asked how you value an asset when it’s value is falling X% per month. The market is forward looking. The bank doesn’t sit down and say, “Well, this MBS is worth X because the value of the underlying collateral has fallen Y% so far.” Instead they make assumptions about further falls in the value of the underlying collateral to come up with a value. And this is what folks buying various tranches of MBS in the market are doing now. They’re making assumptions about how bad things will be in the future in order to come up with a price they’re willing to pay today. In many cases, things will turn out worse than what’s imputed into the current price. And in some cases, things will likely turn out better. It’s going to vary by security.

If I haven’t convinced you of anything, that’s ok. That’s what makes a market, after all. If everyone agreed on the future, there would be no need to open up the exchanges each day.

[patientrenter]

dave lj, I won’t argue against your thesis that market pricing sometimes overestimates true values and sometimes underestimates them.

What we’re discussing is what government actions should be taken in response to that fact. It’s pretty clear that, when market prices may be too high, government does not intervene effectively. (“What bubble?”) It’s also pretty clear that when market prices may be too low, government intervenes vigorously, apparently without limits. This asymmetry is often not acknowledged (e.g. “if you allow us to inflate low prices now, we promise in the next bubble we’ll do what it takes to deflate prices”), but the asymmetry is real. I don’t accept without a good argument that this asymmetric government intervention is better than no intervention. That’s why I am skeptical of your arguments for asset price and banking industry supports now.

[patientrenter]

dave lj, I won’t argue against your thesis that market pricing sometimes overestimates true values and sometimes underestimates them.

What we’re discussing is what government actions should be taken in response to that fact. It’s pretty clear that, when market prices may be too high, government does not intervene effectively. (“What bubble?”) It’s also pretty clear that when market prices may be too low, government intervenes vigorously, apparently without limits. This asymmetry is often not acknowledged (e.g. “if you allow us to inflate low prices now, we promise in the next bubble we’ll do what it takes to deflate prices”), but the asymmetry is real. I don’t accept without a good argument that this asymmetric government intervention is better than no intervention. That’s why I am skeptical of your arguments for asset price and banking industry supports now.

[patientrenter]

dave lj, I won’t argue against your thesis that market pricing sometimes overestimates true values and sometimes underestimates them.

What we’re discussing is what government actions should be taken in response to that fact. It’s pretty clear that, when market prices may be too high, government does not intervene effectively. (“What bubble?”) It’s also pretty clear that when market prices may be too low, government intervenes vigorously, apparently without limits. This asymmetry is often not acknowledged (e.g. “if you allow us to inflate low prices now, we promise in the next bubble we’ll do what it takes to deflate prices”), but the asymmetry is real. I don’t accept without a good argument that this asymmetric government intervention is better than no intervention. That’s why I am skeptical of your arguments for asset price and banking industry supports now.

[patientrenter]

dave lj, I won’t argue against your thesis that market pricing sometimes overestimates true values and sometimes underestimates them.

What we’re discussing is what government actions should be taken in response to that fact. It’s pretty clear that, when market prices may be too high, government does not intervene effectively. (“What bubble?”) It’s also pretty clear that when market prices may be too low, government intervenes vigorously, apparently without limits. This asymmetry is often not acknowledged (e.g. “if you allow us to inflate low prices now, we promise in the next bubble we’ll do what it takes to deflate prices”), but the asymmetry is real. I don’t accept without a good argument that this asymmetric government intervention is better than no intervention. That’s why I am skeptical of your arguments for asset price and banking industry supports now.

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