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

[TheBreeze]

[quote=davelj]
My friends use things called “spreadsheets” and make simplifying (bearish) assumptions about the characteristics of the different portions of the pools. It’s not feel, but rather math. But, more specifically, you do have to make assumptions. That’s necessary for modeling purposes. And those (loss) assumptions will be based on default, foreclosure, and recovery assumptions. But if you define every assumption in the financial world as a “feeling” – which is fine – and therefore not to be used or trusted (which is the implication of your post), then I assume all of your money is in your mattress at home. Because assumptions (“feelings” in your parlance) are how assets get valued. By all means, feel free to do your own analysis on this pool. Yes, there are people doing this. (Wasn’t that obvious from my post?) Yes, it’s worth doing (again… not obvious from my post?). Well at least to some folks apparently.[/quote]

How do they get the recovery assumptions? Are they actually evaluating the individual properties in each pool or are they doing something else? Do you agree that using some type of rent multiplier is a good way to value a property?

Did I understand your original post correctly, in that there are the potential for 25% annual returns? And the reason banks can’t buy this stuff and get those 25% returns is because if the marks keep going down then they will have to engage in some kind of fire sale? Interesting. So are you investing with your own private capital then?

Since you think mark-to-market is a bad idea, do you think the creation of a US Prime Mortgage Security Index as described by Mr. Mortgage in this post is a bad idea?

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

…

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

http://mrmortgage.ml-implode.com/2008/12/20/mortgage-debt-is-more-toxic-than-most-think-even-prime-loansmbs/

By the way, I’m not trying to be a smartass here, I’m just trying to reconcile your view with Mr. Mortgages, as both of you seem to be knowledgeable in this area.

[barnaby33]

Put your mind at ease. A hug is just a symbol of breaking down defensiveness, no slight intended.

I’m not particularly interested in heading back to an agrarian society. I grew up on an apple farm, an unsuccessful one. Manual labor sucks ass. Thats why I am a software engineer.

You kinda dodged my question then answered another one. I asked why someone would buy an investment as toxic as the one that Mish highlighted. I get the concept of MBS in general and its not like I disapprove. You see what I’m getting at and you’ve essentially admitted as well is that there is a large amount of inefficiency in this market. I’ll just take it a step further and call it fraud. What I’d really like to see is us avoiding this in the future. The only way that will happen is if:

• Our system of finance and economy survive
• We punish those who committed the fraud or knowingly allowed it to continue

I wrote a lot more here originally, but Alexander Valley Vineyards cab from Costco (14.50/bottle) finally got the best of me.

Josh

[barnaby33]

Put your mind at ease. A hug is just a symbol of breaking down defensiveness, no slight intended.

I’m not particularly interested in heading back to an agrarian society. I grew up on an apple farm, an unsuccessful one. Manual labor sucks ass. Thats why I am a software engineer.

You kinda dodged my question then answered another one. I asked why someone would buy an investment as toxic as the one that Mish highlighted. I get the concept of MBS in general and its not like I disapprove. You see what I’m getting at and you’ve essentially admitted as well is that there is a large amount of inefficiency in this market. I’ll just take it a step further and call it fraud. What I’d really like to see is us avoiding this in the future. The only way that will happen is if:

• Our system of finance and economy survive
• We punish those who committed the fraud or knowingly allowed it to continue

I wrote a lot more here originally, but Alexander Valley Vineyards cab from Costco (14.50/bottle) finally got the best of me.

Josh

[barnaby33]

Put your mind at ease. A hug is just a symbol of breaking down defensiveness, no slight intended.

I’m not particularly interested in heading back to an agrarian society. I grew up on an apple farm, an unsuccessful one. Manual labor sucks ass. Thats why I am a software engineer.

You kinda dodged my question then answered another one. I asked why someone would buy an investment as toxic as the one that Mish highlighted. I get the concept of MBS in general and its not like I disapprove. You see what I’m getting at and you’ve essentially admitted as well is that there is a large amount of inefficiency in this market. I’ll just take it a step further and call it fraud. What I’d really like to see is us avoiding this in the future. The only way that will happen is if:

• Our system of finance and economy survive
• We punish those who committed the fraud or knowingly allowed it to continue

I wrote a lot more here originally, but Alexander Valley Vineyards cab from Costco (14.50/bottle) finally got the best of me.

Josh

[barnaby33]

Put your mind at ease. A hug is just a symbol of breaking down defensiveness, no slight intended.

I’m not particularly interested in heading back to an agrarian society. I grew up on an apple farm, an unsuccessful one. Manual labor sucks ass. Thats why I am a software engineer.

You kinda dodged my question then answered another one. I asked why someone would buy an investment as toxic as the one that Mish highlighted. I get the concept of MBS in general and its not like I disapprove. You see what I’m getting at and you’ve essentially admitted as well is that there is a large amount of inefficiency in this market. I’ll just take it a step further and call it fraud. What I’d really like to see is us avoiding this in the future. The only way that will happen is if:

• Our system of finance and economy survive
• We punish those who committed the fraud or knowingly allowed it to continue

I wrote a lot more here originally, but Alexander Valley Vineyards cab from Costco (14.50/bottle) finally got the best of me.

Josh

[barnaby33]

Put your mind at ease. A hug is just a symbol of breaking down defensiveness, no slight intended.

I’m not particularly interested in heading back to an agrarian society. I grew up on an apple farm, an unsuccessful one. Manual labor sucks ass. Thats why I am a software engineer.

You kinda dodged my question then answered another one. I asked why someone would buy an investment as toxic as the one that Mish highlighted. I get the concept of MBS in general and its not like I disapprove. You see what I’m getting at and you’ve essentially admitted as well is that there is a large amount of inefficiency in this market. I’ll just take it a step further and call it fraud. What I’d really like to see is us avoiding this in the future. The only way that will happen is if:

• Our system of finance and economy survive
• We punish those who committed the fraud or knowingly allowed it to continue

I wrote a lot more here originally, but Alexander Valley Vineyards cab from Costco (14.50/bottle) finally got the best of me.

Josh

[patb]

irst Lien Credit Grade Category: “A”
Loan-To-Value Ratio: Maximum of 100%
Debt-To-Income Ratio: Maximum of 55%
Loan Amount: Maximum of $1,000,000
Credit Bureau Risk Score: Minimum of—
500 for loan amounts up to $700,000,
560 for loan amounts of $700,001 to $750,000,
580 for loan amounts of $750,001 to $850,000, or
600 for loan amounts of $850,001 to $1,000,000.
Mortgage History: No more than 1 non-consecutive delinquency of 30 days during the past 12 months.
Bankruptcy: At least 1 day since discharge or 2 years since dismissal of Chapter 7 or 13 Bankruptcy.
Foreclosure/Notice of Default: At least 3 years since foreclosure/notice of default released.

(They call that Grade A?)

i’d buy these at 3 cents on the dollar,

[patb]

irst Lien Credit Grade Category: “A”
Loan-To-Value Ratio: Maximum of 100%
Debt-To-Income Ratio: Maximum of 55%
Loan Amount: Maximum of $1,000,000
Credit Bureau Risk Score: Minimum of—
500 for loan amounts up to $700,000,
560 for loan amounts of $700,001 to $750,000,
580 for loan amounts of $750,001 to $850,000, or
600 for loan amounts of $850,001 to $1,000,000.
Mortgage History: No more than 1 non-consecutive delinquency of 30 days during the past 12 months.
Bankruptcy: At least 1 day since discharge or 2 years since dismissal of Chapter 7 or 13 Bankruptcy.
Foreclosure/Notice of Default: At least 3 years since foreclosure/notice of default released.

(They call that Grade A?)

i’d buy these at 3 cents on the dollar,

[patb]

irst Lien Credit Grade Category: “A”
Loan-To-Value Ratio: Maximum of 100%
Debt-To-Income Ratio: Maximum of 55%
Loan Amount: Maximum of $1,000,000
Credit Bureau Risk Score: Minimum of—
500 for loan amounts up to $700,000,
560 for loan amounts of $700,001 to $750,000,
580 for loan amounts of $750,001 to $850,000, or
600 for loan amounts of $850,001 to $1,000,000.
Mortgage History: No more than 1 non-consecutive delinquency of 30 days during the past 12 months.
Bankruptcy: At least 1 day since discharge or 2 years since dismissal of Chapter 7 or 13 Bankruptcy.
Foreclosure/Notice of Default: At least 3 years since foreclosure/notice of default released.

(They call that Grade A?)

i’d buy these at 3 cents on the dollar,

[patb]

irst Lien Credit Grade Category: “A”
Loan-To-Value Ratio: Maximum of 100%
Debt-To-Income Ratio: Maximum of 55%
Loan Amount: Maximum of $1,000,000
Credit Bureau Risk Score: Minimum of—
500 for loan amounts up to $700,000,
560 for loan amounts of $700,001 to $750,000,
580 for loan amounts of $750,001 to $850,000, or
600 for loan amounts of $850,001 to $1,000,000.
Mortgage History: No more than 1 non-consecutive delinquency of 30 days during the past 12 months.
Bankruptcy: At least 1 day since discharge or 2 years since dismissal of Chapter 7 or 13 Bankruptcy.
Foreclosure/Notice of Default: At least 3 years since foreclosure/notice of default released.

(They call that Grade A?)

i’d buy these at 3 cents on the dollar,

[patb]

irst Lien Credit Grade Category: “A”
Loan-To-Value Ratio: Maximum of 100%
Debt-To-Income Ratio: Maximum of 55%
Loan Amount: Maximum of $1,000,000
Credit Bureau Risk Score: Minimum of—
500 for loan amounts up to $700,000,
560 for loan amounts of $700,001 to $750,000,
580 for loan amounts of $750,001 to $850,000, or
600 for loan amounts of $850,001 to $1,000,000.
Mortgage History: No more than 1 non-consecutive delinquency of 30 days during the past 12 months.
Bankruptcy: At least 1 day since discharge or 2 years since dismissal of Chapter 7 or 13 Bankruptcy.
Foreclosure/Notice of Default: At least 3 years since foreclosure/notice of default released.

(They call that Grade A?)

i’d buy these at 3 cents on the dollar,

[davelj]

[quote=TheBreeze][quote=davelj]
But, more specifically, you do have to make assumptions. That’s necessary for modeling purposes. And those (loss) assumptions will be based on default, foreclosure, and recovery assumptions. [/quote]

How do they get the recovery assumptions? Are they actually evaluating the individual properties in each pool or are they doing something else? Do you agree that using some type of rent multiplier is a good way to value a property?

Did I understand your original post correctly, in that there are the potential for 25% annual returns? And the reason banks can’t buy this stuff and get those 25% returns is because if the marks keep going down then they will have to engage in some kind of fire sale? Interesting. So are you investing with your own private capital then?

Since you think mark-to-market is a bad idea, do you think the creation of a US Prime Mortgage Security Index as described by Mr. Mortgage in this post is a bad idea?

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

…

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

http://mrmortgage.ml-implode.com/2008/12/20/mortgage-debt-is-more-toxic-than-most-think-even-prime-loansmbs/

By the way, I’m not trying to be a smartass here, I’m just trying to reconcile your view with Mr. Mortgages, as both of you seem to be knowledgeable in this area.

[/quote]

In order:

The recovery assumptions are based on what’s happening in the market at the moment, then discounted further by how bad things are likely to get (obviously, there’s some art in this process). No, they don’t actually evaluate the individual properties but rather evaluate large groups of properties with similar characteristics (geography, FICO, LTV at origination, etc), just as an insurance analyst isn’t going to analyze every single life insurance policy that a company underwrites to determine the company’s value. You let the law of large numbers work for you.

Yes, it appears that there is the potential for 25%+ returns in some of these pigs. But there is also the likelihood of -100% returns in a lot of them. And there’s the rub. I cannot buy these securities personally because they tend to trade in multiple $million blocks. Neither of my two partnerships can buy them either because they are outside of what my charter allows. But I’m currently working with a group to raise money for a new partnership which would allow us to buy some of these securities, among other things. One of the guys I’m working with on this project actually structured over 100 of these securitizations while at Morgan Stanley. He was one of the chief sausage makers (and was fully aware that the sausage was stinky) and he’s seeing value in some of these securities (in others he’s seeing additional big losses, but that’s another issue.)

I looked at the Mr. Mortgage piece and agreed with a lot of what he wrote, although two things stuck out: (1) “The Market is fully functional at the right price.” Factually true and completely useless statement. If forced to, I can sell my condo tomorrow “at the right price.” But if I have a year to sell it, I’m thinking the price will be much better. (2) “There are plenty of funds who will buy hundreds of millions of loans…” Again, factually true, but due to the scale of the situation, completely useless. The residential MBS market is in the $trillions. Let’s assume that there’s $50 billion of long-term capital looking to take advantage of some of these purportedly mispriced securities. That $50 billion in demand is a tiny drop in the bucket compared to what’s out there in supply. His argument appears to be that because he anecdotally knows of funds that want to buy this paper, then therefore there’s plenty of demand out there and the prices are efficient. If you look at the scale of the market, that’s just complete nonsense.

I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.

Here’s the real problem that must be acknowledged. Since the advent of “modern” banking (I think in Italy in the 15th century or something like that), not a day has passed during which the world’s financial system could have marked its assets to market (that is, the price at which the assets could be sold within a week, let’s say) and not been completely, totally insolvent. Pick the most prosperous period you can find in modern history and there’s no way on earth that there would be enough buyers out there to take on such an enormous deluge of assets given the leverage involved, even if leverage were cut in half. That’s axiomatic if you think about it for 5 seconds. We’re seeing a micro example of this phenomenon in our efforts to liquidate Bear Stearns and AIG. Now they have some crappy assets and were overleveraged. No doubt. They deserved to fail. But if you force these folks to sell even the “good” assets immediately, well the prices are going to be a fraction of what they’d get given a little breathing room. Our financial system is not, and has never, been able to accommodate everyone’s desire to get liquid at the same time. A slavish adherence to mark-to-market accounting does not recognize this fact. Again, I don’t have a good answer. I’m just saying that it’s a lot more complicated than many would have you believe. And anyone who believes otherwise is either (1) lying, or (2) doesn’t understand how the pieces fit together.

[davelj]

[quote=TheBreeze][quote=davelj]
But, more specifically, you do have to make assumptions. That’s necessary for modeling purposes. And those (loss) assumptions will be based on default, foreclosure, and recovery assumptions. [/quote]

How do they get the recovery assumptions? Are they actually evaluating the individual properties in each pool or are they doing something else? Do you agree that using some type of rent multiplier is a good way to value a property?

Did I understand your original post correctly, in that there are the potential for 25% annual returns? And the reason banks can’t buy this stuff and get those 25% returns is because if the marks keep going down then they will have to engage in some kind of fire sale? Interesting. So are you investing with your own private capital then?

Since you think mark-to-market is a bad idea, do you think the creation of a US Prime Mortgage Security Index as described by Mr. Mortgage in this post is a bad idea?

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

…

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

http://mrmortgage.ml-implode.com/2008/12/20/mortgage-debt-is-more-toxic-than-most-think-even-prime-loansmbs/

By the way, I’m not trying to be a smartass here, I’m just trying to reconcile your view with Mr. Mortgages, as both of you seem to be knowledgeable in this area.

[/quote]

In order:

The recovery assumptions are based on what’s happening in the market at the moment, then discounted further by how bad things are likely to get (obviously, there’s some art in this process). No, they don’t actually evaluate the individual properties but rather evaluate large groups of properties with similar characteristics (geography, FICO, LTV at origination, etc), just as an insurance analyst isn’t going to analyze every single life insurance policy that a company underwrites to determine the company’s value. You let the law of large numbers work for you.

Yes, it appears that there is the potential for 25%+ returns in some of these pigs. But there is also the likelihood of -100% returns in a lot of them. And there’s the rub. I cannot buy these securities personally because they tend to trade in multiple $million blocks. Neither of my two partnerships can buy them either because they are outside of what my charter allows. But I’m currently working with a group to raise money for a new partnership which would allow us to buy some of these securities, among other things. One of the guys I’m working with on this project actually structured over 100 of these securitizations while at Morgan Stanley. He was one of the chief sausage makers (and was fully aware that the sausage was stinky) and he’s seeing value in some of these securities (in others he’s seeing additional big losses, but that’s another issue.)

I looked at the Mr. Mortgage piece and agreed with a lot of what he wrote, although two things stuck out: (1) “The Market is fully functional at the right price.” Factually true and completely useless statement. If forced to, I can sell my condo tomorrow “at the right price.” But if I have a year to sell it, I’m thinking the price will be much better. (2) “There are plenty of funds who will buy hundreds of millions of loans…” Again, factually true, but due to the scale of the situation, completely useless. The residential MBS market is in the $trillions. Let’s assume that there’s $50 billion of long-term capital looking to take advantage of some of these purportedly mispriced securities. That $50 billion in demand is a tiny drop in the bucket compared to what’s out there in supply. His argument appears to be that because he anecdotally knows of funds that want to buy this paper, then therefore there’s plenty of demand out there and the prices are efficient. If you look at the scale of the market, that’s just complete nonsense.

I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.

Here’s the real problem that must be acknowledged. Since the advent of “modern” banking (I think in Italy in the 15th century or something like that), not a day has passed during which the world’s financial system could have marked its assets to market (that is, the price at which the assets could be sold within a week, let’s say) and not been completely, totally insolvent. Pick the most prosperous period you can find in modern history and there’s no way on earth that there would be enough buyers out there to take on such an enormous deluge of assets given the leverage involved, even if leverage were cut in half. That’s axiomatic if you think about it for 5 seconds. We’re seeing a micro example of this phenomenon in our efforts to liquidate Bear Stearns and AIG. Now they have some crappy assets and were overleveraged. No doubt. They deserved to fail. But if you force these folks to sell even the “good” assets immediately, well the prices are going to be a fraction of what they’d get given a little breathing room. Our financial system is not, and has never, been able to accommodate everyone’s desire to get liquid at the same time. A slavish adherence to mark-to-market accounting does not recognize this fact. Again, I don’t have a good answer. I’m just saying that it’s a lot more complicated than many would have you believe. And anyone who believes otherwise is either (1) lying, or (2) doesn’t understand how the pieces fit together.

[davelj]

[quote=TheBreeze][quote=davelj]
But, more specifically, you do have to make assumptions. That’s necessary for modeling purposes. And those (loss) assumptions will be based on default, foreclosure, and recovery assumptions. [/quote]

How do they get the recovery assumptions? Are they actually evaluating the individual properties in each pool or are they doing something else? Do you agree that using some type of rent multiplier is a good way to value a property?

Did I understand your original post correctly, in that there are the potential for 25% annual returns? And the reason banks can’t buy this stuff and get those 25% returns is because if the marks keep going down then they will have to engage in some kind of fire sale? Interesting. So are you investing with your own private capital then?

Since you think mark-to-market is a bad idea, do you think the creation of a US Prime Mortgage Security Index as described by Mr. Mortgage in this post is a bad idea?

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

…

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

http://mrmortgage.ml-implode.com/2008/12/20/mortgage-debt-is-more-toxic-than-most-think-even-prime-loansmbs/

By the way, I’m not trying to be a smartass here, I’m just trying to reconcile your view with Mr. Mortgages, as both of you seem to be knowledgeable in this area.

[/quote]

In order:

The recovery assumptions are based on what’s happening in the market at the moment, then discounted further by how bad things are likely to get (obviously, there’s some art in this process). No, they don’t actually evaluate the individual properties but rather evaluate large groups of properties with similar characteristics (geography, FICO, LTV at origination, etc), just as an insurance analyst isn’t going to analyze every single life insurance policy that a company underwrites to determine the company’s value. You let the law of large numbers work for you.

Yes, it appears that there is the potential for 25%+ returns in some of these pigs. But there is also the likelihood of -100% returns in a lot of them. And there’s the rub. I cannot buy these securities personally because they tend to trade in multiple $million blocks. Neither of my two partnerships can buy them either because they are outside of what my charter allows. But I’m currently working with a group to raise money for a new partnership which would allow us to buy some of these securities, among other things. One of the guys I’m working with on this project actually structured over 100 of these securitizations while at Morgan Stanley. He was one of the chief sausage makers (and was fully aware that the sausage was stinky) and he’s seeing value in some of these securities (in others he’s seeing additional big losses, but that’s another issue.)

I looked at the Mr. Mortgage piece and agreed with a lot of what he wrote, although two things stuck out: (1) “The Market is fully functional at the right price.” Factually true and completely useless statement. If forced to, I can sell my condo tomorrow “at the right price.” But if I have a year to sell it, I’m thinking the price will be much better. (2) “There are plenty of funds who will buy hundreds of millions of loans…” Again, factually true, but due to the scale of the situation, completely useless. The residential MBS market is in the $trillions. Let’s assume that there’s $50 billion of long-term capital looking to take advantage of some of these purportedly mispriced securities. That $50 billion in demand is a tiny drop in the bucket compared to what’s out there in supply. His argument appears to be that because he anecdotally knows of funds that want to buy this paper, then therefore there’s plenty of demand out there and the prices are efficient. If you look at the scale of the market, that’s just complete nonsense.

I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.

Here’s the real problem that must be acknowledged. Since the advent of “modern” banking (I think in Italy in the 15th century or something like that), not a day has passed during which the world’s financial system could have marked its assets to market (that is, the price at which the assets could be sold within a week, let’s say) and not been completely, totally insolvent. Pick the most prosperous period you can find in modern history and there’s no way on earth that there would be enough buyers out there to take on such an enormous deluge of assets given the leverage involved, even if leverage were cut in half. That’s axiomatic if you think about it for 5 seconds. We’re seeing a micro example of this phenomenon in our efforts to liquidate Bear Stearns and AIG. Now they have some crappy assets and were overleveraged. No doubt. They deserved to fail. But if you force these folks to sell even the “good” assets immediately, well the prices are going to be a fraction of what they’d get given a little breathing room. Our financial system is not, and has never, been able to accommodate everyone’s desire to get liquid at the same time. A slavish adherence to mark-to-market accounting does not recognize this fact. Again, I don’t have a good answer. I’m just saying that it’s a lot more complicated than many would have you believe. And anyone who believes otherwise is either (1) lying, or (2) doesn’t understand how the pieces fit together.

[davelj]

[quote=TheBreeze][quote=davelj]
But, more specifically, you do have to make assumptions. That’s necessary for modeling purposes. And those (loss) assumptions will be based on default, foreclosure, and recovery assumptions. [/quote]

How do they get the recovery assumptions? Are they actually evaluating the individual properties in each pool or are they doing something else? Do you agree that using some type of rent multiplier is a good way to value a property?

Did I understand your original post correctly, in that there are the potential for 25% annual returns? And the reason banks can’t buy this stuff and get those 25% returns is because if the marks keep going down then they will have to engage in some kind of fire sale? Interesting. So are you investing with your own private capital then?

Since you think mark-to-market is a bad idea, do you think the creation of a US Prime Mortgage Security Index as described by Mr. Mortgage in this post is a bad idea?

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

…

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

http://mrmortgage.ml-implode.com/2008/12/20/mortgage-debt-is-more-toxic-than-most-think-even-prime-loansmbs/

By the way, I’m not trying to be a smartass here, I’m just trying to reconcile your view with Mr. Mortgages, as both of you seem to be knowledgeable in this area.

[/quote]

In order:

The recovery assumptions are based on what’s happening in the market at the moment, then discounted further by how bad things are likely to get (obviously, there’s some art in this process). No, they don’t actually evaluate the individual properties but rather evaluate large groups of properties with similar characteristics (geography, FICO, LTV at origination, etc), just as an insurance analyst isn’t going to analyze every single life insurance policy that a company underwrites to determine the company’s value. You let the law of large numbers work for you.

Yes, it appears that there is the potential for 25%+ returns in some of these pigs. But there is also the likelihood of -100% returns in a lot of them. And there’s the rub. I cannot buy these securities personally because they tend to trade in multiple $million blocks. Neither of my two partnerships can buy them either because they are outside of what my charter allows. But I’m currently working with a group to raise money for a new partnership which would allow us to buy some of these securities, among other things. One of the guys I’m working with on this project actually structured over 100 of these securitizations while at Morgan Stanley. He was one of the chief sausage makers (and was fully aware that the sausage was stinky) and he’s seeing value in some of these securities (in others he’s seeing additional big losses, but that’s another issue.)

I looked at the Mr. Mortgage piece and agreed with a lot of what he wrote, although two things stuck out: (1) “The Market is fully functional at the right price.” Factually true and completely useless statement. If forced to, I can sell my condo tomorrow “at the right price.” But if I have a year to sell it, I’m thinking the price will be much better. (2) “There are plenty of funds who will buy hundreds of millions of loans…” Again, factually true, but due to the scale of the situation, completely useless. The residential MBS market is in the $trillions. Let’s assume that there’s $50 billion of long-term capital looking to take advantage of some of these purportedly mispriced securities. That $50 billion in demand is a tiny drop in the bucket compared to what’s out there in supply. His argument appears to be that because he anecdotally knows of funds that want to buy this paper, then therefore there’s plenty of demand out there and the prices are efficient. If you look at the scale of the market, that’s just complete nonsense.

I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.

Here’s the real problem that must be acknowledged. Since the advent of “modern” banking (I think in Italy in the 15th century or something like that), not a day has passed during which the world’s financial system could have marked its assets to market (that is, the price at which the assets could be sold within a week, let’s say) and not been completely, totally insolvent. Pick the most prosperous period you can find in modern history and there’s no way on earth that there would be enough buyers out there to take on such an enormous deluge of assets given the leverage involved, even if leverage were cut in half. That’s axiomatic if you think about it for 5 seconds. We’re seeing a micro example of this phenomenon in our efforts to liquidate Bear Stearns and AIG. Now they have some crappy assets and were overleveraged. No doubt. They deserved to fail. But if you force these folks to sell even the “good” assets immediately, well the prices are going to be a fraction of what they’d get given a little breathing room. Our financial system is not, and has never, been able to accommodate everyone’s desire to get liquid at the same time. A slavish adherence to mark-to-market accounting does not recognize this fact. Again, I don’t have a good answer. I’m just saying that it’s a lot more complicated than many would have you believe. And anyone who believes otherwise is either (1) lying, or (2) doesn’t understand how the pieces fit together.

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