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

[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=barnaby33]
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.
Josh[/quote]

Ok, I think I understand. I thought you were asking why someone would buy a slice of that particular MBS and I was asking you, well, what are the prices, parameters, etc. Now I think what you were asking was why someone would have bought that security at par in its original form given how horribly pathetic the collateral was. Which is a more logical question.

Lots of answers, all bad ones. Pure stupidity, for one. Two, choosing to hedge short-term career risk over longer-term problems. (Some guy’s boss: “Look, Chet, the guys at Bear are making money hand over fist on this stuff. Why aren’t you diving in? Maybe this isn’t the right job for you.” When you’re making a couple a million a year, lots of folks will take what they can get in the short term and assume that the long term will work itself out.) Three, group think. Can so many folks be so wrong about such a huge segment of the market? Surely not!! Oops! I’m sure there are others, but that’s off the top of my head.

[davelj]

[quote=barnaby33]
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.
Josh[/quote]

Ok, I think I understand. I thought you were asking why someone would buy a slice of that particular MBS and I was asking you, well, what are the prices, parameters, etc. Now I think what you were asking was why someone would have bought that security at par in its original form given how horribly pathetic the collateral was. Which is a more logical question.

Lots of answers, all bad ones. Pure stupidity, for one. Two, choosing to hedge short-term career risk over longer-term problems. (Some guy’s boss: “Look, Chet, the guys at Bear are making money hand over fist on this stuff. Why aren’t you diving in? Maybe this isn’t the right job for you.” When you’re making a couple a million a year, lots of folks will take what they can get in the short term and assume that the long term will work itself out.) Three, group think. Can so many folks be so wrong about such a huge segment of the market? Surely not!! Oops! I’m sure there are others, but that’s off the top of my head.

[davelj]

[quote=barnaby33]
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.
Josh[/quote]

Ok, I think I understand. I thought you were asking why someone would buy a slice of that particular MBS and I was asking you, well, what are the prices, parameters, etc. Now I think what you were asking was why someone would have bought that security at par in its original form given how horribly pathetic the collateral was. Which is a more logical question.

Lots of answers, all bad ones. Pure stupidity, for one. Two, choosing to hedge short-term career risk over longer-term problems. (Some guy’s boss: “Look, Chet, the guys at Bear are making money hand over fist on this stuff. Why aren’t you diving in? Maybe this isn’t the right job for you.” When you’re making a couple a million a year, lots of folks will take what they can get in the short term and assume that the long term will work itself out.) Three, group think. Can so many folks be so wrong about such a huge segment of the market? Surely not!! Oops! I’m sure there are others, but that’s off the top of my head.

[davelj]

[quote=barnaby33]
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.
Josh[/quote]

Ok, I think I understand. I thought you were asking why someone would buy a slice of that particular MBS and I was asking you, well, what are the prices, parameters, etc. Now I think what you were asking was why someone would have bought that security at par in its original form given how horribly pathetic the collateral was. Which is a more logical question.

Lots of answers, all bad ones. Pure stupidity, for one. Two, choosing to hedge short-term career risk over longer-term problems. (Some guy’s boss: “Look, Chet, the guys at Bear are making money hand over fist on this stuff. Why aren’t you diving in? Maybe this isn’t the right job for you.” When you’re making a couple a million a year, lots of folks will take what they can get in the short term and assume that the long term will work itself out.) Three, group think. Can so many folks be so wrong about such a huge segment of the market? Surely not!! Oops! I’m sure there are others, but that’s off the top of my head.

[davelj]

[quote=barnaby33]
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.
Josh[/quote]

Ok, I think I understand. I thought you were asking why someone would buy a slice of that particular MBS and I was asking you, well, what are the prices, parameters, etc. Now I think what you were asking was why someone would have bought that security at par in its original form given how horribly pathetic the collateral was. Which is a more logical question.

Lots of answers, all bad ones. Pure stupidity, for one. Two, choosing to hedge short-term career risk over longer-term problems. (Some guy’s boss: “Look, Chet, the guys at Bear are making money hand over fist on this stuff. Why aren’t you diving in? Maybe this isn’t the right job for you.” When you’re making a couple a million a year, lots of folks will take what they can get in the short term and assume that the long term will work itself out.) Three, group think. Can so many folks be so wrong about such a huge segment of the market? Surely not!! Oops! I’m sure there are others, but that’s off the top of my head.

[TheBreeze]

[quote=davelj]
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.
[/quote]

True, but the insurance analyst’s valuation opinion is only going to be as good as the underwriting on each of those individual policies. For banks, the underwriting has been atrocious for the last several years. Garbage in, garbage out.

[quote=davelj]
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.
[/quote]

No one is making the banks sell their assets within a week, so this is hyperbole on your part. Asset prices will likely continue going down throughout 2009 (absent massive government stimulus) so banks could be given a year or more to sell and they would still be insolvent. Banks are insolvent because they are insolvent.

In an ideal world where there wasn’t all this financial “innovation”, banks would borrow long at x% and lend for the same time period at x% + y%. Further, banks would value collateral conservatively and only lend against a portion of that collateral (say 80% maximum). If banks did this, and the borrower stopped paying, then they could liquidate the collateral in a reasonable period and pay off their obligations.

But they didn’t do that. What banks did during the recent “bankster” era is borrow short, lend long against 100+% of collateral, and push for crappy underwriting (stated income, inflated appraisals, etc). I’m no bank historian, but I would imagine that any time banks get away from sound money management principles you get these types of bubbles.

So the problem isn’t that banks are being forced to sell their assets within a week, the problem is that the assets are feces and, like you say below, everyone is trying to liquidate their feces at the same time.

[quote=davelj]
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.
[/quote]

Maybe the market recognizes that the “good” assets were only “good” during a housing bubble? Who’s to say what assets are going to be “good” on the other side of this recession/depression?

[quote=davelj]
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.[/quote]

What happens if we just let all the bad banks fail? Obviously we have massive unemployment, but the government could just extend unemployment benefits and do massive public works projects to help reduce that. To me, this is preferable to propping up the value of crappy assets as it will force people into productive work.

Philosophically, I’m opposed to the government getting involved in propping up asset prices as it just further distorts the market and keeps people employed in unproductive jobs. Capitalism is all about creating efficiencies and propping up the prices of crappy assets is not efficient. I would rather see the government invest in research, alternative energy, infrastructure improvement, or something that is likely to benefit society (DARPANet anyone?) than get involved with propping up the prices of crappy assets. Maybe the government makes money on those assets, but buying crappy assets is more likely to benefit banksters than society as a whole.

Thanks for your responses on this.

[TheBreeze]

[quote=davelj]
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.
[/quote]

True, but the insurance analyst’s valuation opinion is only going to be as good as the underwriting on each of those individual policies. For banks, the underwriting has been atrocious for the last several years. Garbage in, garbage out.

[quote=davelj]
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.
[/quote]

No one is making the banks sell their assets within a week, so this is hyperbole on your part. Asset prices will likely continue going down throughout 2009 (absent massive government stimulus) so banks could be given a year or more to sell and they would still be insolvent. Banks are insolvent because they are insolvent.

In an ideal world where there wasn’t all this financial “innovation”, banks would borrow long at x% and lend for the same time period at x% + y%. Further, banks would value collateral conservatively and only lend against a portion of that collateral (say 80% maximum). If banks did this, and the borrower stopped paying, then they could liquidate the collateral in a reasonable period and pay off their obligations.

But they didn’t do that. What banks did during the recent “bankster” era is borrow short, lend long against 100+% of collateral, and push for crappy underwriting (stated income, inflated appraisals, etc). I’m no bank historian, but I would imagine that any time banks get away from sound money management principles you get these types of bubbles.

So the problem isn’t that banks are being forced to sell their assets within a week, the problem is that the assets are feces and, like you say below, everyone is trying to liquidate their feces at the same time.

[quote=davelj]
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.
[/quote]

Maybe the market recognizes that the “good” assets were only “good” during a housing bubble? Who’s to say what assets are going to be “good” on the other side of this recession/depression?

[quote=davelj]
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.[/quote]

What happens if we just let all the bad banks fail? Obviously we have massive unemployment, but the government could just extend unemployment benefits and do massive public works projects to help reduce that. To me, this is preferable to propping up the value of crappy assets as it will force people into productive work.

Philosophically, I’m opposed to the government getting involved in propping up asset prices as it just further distorts the market and keeps people employed in unproductive jobs. Capitalism is all about creating efficiencies and propping up the prices of crappy assets is not efficient. I would rather see the government invest in research, alternative energy, infrastructure improvement, or something that is likely to benefit society (DARPANet anyone?) than get involved with propping up the prices of crappy assets. Maybe the government makes money on those assets, but buying crappy assets is more likely to benefit banksters than society as a whole.

Thanks for your responses on this.

[TheBreeze]

[quote=davelj]
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.
[/quote]

True, but the insurance analyst’s valuation opinion is only going to be as good as the underwriting on each of those individual policies. For banks, the underwriting has been atrocious for the last several years. Garbage in, garbage out.

[quote=davelj]
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.
[/quote]

No one is making the banks sell their assets within a week, so this is hyperbole on your part. Asset prices will likely continue going down throughout 2009 (absent massive government stimulus) so banks could be given a year or more to sell and they would still be insolvent. Banks are insolvent because they are insolvent.

In an ideal world where there wasn’t all this financial “innovation”, banks would borrow long at x% and lend for the same time period at x% + y%. Further, banks would value collateral conservatively and only lend against a portion of that collateral (say 80% maximum). If banks did this, and the borrower stopped paying, then they could liquidate the collateral in a reasonable period and pay off their obligations.

But they didn’t do that. What banks did during the recent “bankster” era is borrow short, lend long against 100+% of collateral, and push for crappy underwriting (stated income, inflated appraisals, etc). I’m no bank historian, but I would imagine that any time banks get away from sound money management principles you get these types of bubbles.

So the problem isn’t that banks are being forced to sell their assets within a week, the problem is that the assets are feces and, like you say below, everyone is trying to liquidate their feces at the same time.

[quote=davelj]
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.
[/quote]

Maybe the market recognizes that the “good” assets were only “good” during a housing bubble? Who’s to say what assets are going to be “good” on the other side of this recession/depression?

[quote=davelj]
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.[/quote]

What happens if we just let all the bad banks fail? Obviously we have massive unemployment, but the government could just extend unemployment benefits and do massive public works projects to help reduce that. To me, this is preferable to propping up the value of crappy assets as it will force people into productive work.

Philosophically, I’m opposed to the government getting involved in propping up asset prices as it just further distorts the market and keeps people employed in unproductive jobs. Capitalism is all about creating efficiencies and propping up the prices of crappy assets is not efficient. I would rather see the government invest in research, alternative energy, infrastructure improvement, or something that is likely to benefit society (DARPANet anyone?) than get involved with propping up the prices of crappy assets. Maybe the government makes money on those assets, but buying crappy assets is more likely to benefit banksters than society as a whole.

Thanks for your responses on this.

[TheBreeze]

[quote=davelj]
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.
[/quote]

True, but the insurance analyst’s valuation opinion is only going to be as good as the underwriting on each of those individual policies. For banks, the underwriting has been atrocious for the last several years. Garbage in, garbage out.

[quote=davelj]
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.
[/quote]

No one is making the banks sell their assets within a week, so this is hyperbole on your part. Asset prices will likely continue going down throughout 2009 (absent massive government stimulus) so banks could be given a year or more to sell and they would still be insolvent. Banks are insolvent because they are insolvent.

In an ideal world where there wasn’t all this financial “innovation”, banks would borrow long at x% and lend for the same time period at x% + y%. Further, banks would value collateral conservatively and only lend against a portion of that collateral (say 80% maximum). If banks did this, and the borrower stopped paying, then they could liquidate the collateral in a reasonable period and pay off their obligations.

But they didn’t do that. What banks did during the recent “bankster” era is borrow short, lend long against 100+% of collateral, and push for crappy underwriting (stated income, inflated appraisals, etc). I’m no bank historian, but I would imagine that any time banks get away from sound money management principles you get these types of bubbles.

So the problem isn’t that banks are being forced to sell their assets within a week, the problem is that the assets are feces and, like you say below, everyone is trying to liquidate their feces at the same time.

[quote=davelj]
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.
[/quote]

Maybe the market recognizes that the “good” assets were only “good” during a housing bubble? Who’s to say what assets are going to be “good” on the other side of this recession/depression?

[quote=davelj]
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.[/quote]

What happens if we just let all the bad banks fail? Obviously we have massive unemployment, but the government could just extend unemployment benefits and do massive public works projects to help reduce that. To me, this is preferable to propping up the value of crappy assets as it will force people into productive work.

Philosophically, I’m opposed to the government getting involved in propping up asset prices as it just further distorts the market and keeps people employed in unproductive jobs. Capitalism is all about creating efficiencies and propping up the prices of crappy assets is not efficient. I would rather see the government invest in research, alternative energy, infrastructure improvement, or something that is likely to benefit society (DARPANet anyone?) than get involved with propping up the prices of crappy assets. Maybe the government makes money on those assets, but buying crappy assets is more likely to benefit banksters than society as a whole.

Thanks for your responses on this.

[TheBreeze]

[quote=davelj]
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.
[/quote]

True, but the insurance analyst’s valuation opinion is only going to be as good as the underwriting on each of those individual policies. For banks, the underwriting has been atrocious for the last several years. Garbage in, garbage out.

[quote=davelj]
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.
[/quote]

No one is making the banks sell their assets within a week, so this is hyperbole on your part. Asset prices will likely continue going down throughout 2009 (absent massive government stimulus) so banks could be given a year or more to sell and they would still be insolvent. Banks are insolvent because they are insolvent.

In an ideal world where there wasn’t all this financial “innovation”, banks would borrow long at x% and lend for the same time period at x% + y%. Further, banks would value collateral conservatively and only lend against a portion of that collateral (say 80% maximum). If banks did this, and the borrower stopped paying, then they could liquidate the collateral in a reasonable period and pay off their obligations.

But they didn’t do that. What banks did during the recent “bankster” era is borrow short, lend long against 100+% of collateral, and push for crappy underwriting (stated income, inflated appraisals, etc). I’m no bank historian, but I would imagine that any time banks get away from sound money management principles you get these types of bubbles.

So the problem isn’t that banks are being forced to sell their assets within a week, the problem is that the assets are feces and, like you say below, everyone is trying to liquidate their feces at the same time.

[quote=davelj]
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.
[/quote]

Maybe the market recognizes that the “good” assets were only “good” during a housing bubble? Who’s to say what assets are going to be “good” on the other side of this recession/depression?

[quote=davelj]
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.[/quote]

What happens if we just let all the bad banks fail? Obviously we have massive unemployment, but the government could just extend unemployment benefits and do massive public works projects to help reduce that. To me, this is preferable to propping up the value of crappy assets as it will force people into productive work.

Philosophically, I’m opposed to the government getting involved in propping up asset prices as it just further distorts the market and keeps people employed in unproductive jobs. Capitalism is all about creating efficiencies and propping up the prices of crappy assets is not efficient. I would rather see the government invest in research, alternative energy, infrastructure improvement, or something that is likely to benefit society (DARPANet anyone?) than get involved with propping up the prices of crappy assets. Maybe the government makes money on those assets, but buying crappy assets is more likely to benefit banksters than society as a whole.

Thanks for your responses on this.

[TheBreeze]

[quote=davelj]
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.
[/quote]

I read his argument as something like this: “The smart buyers out there do not yet see value at the prices these things are selling formarked at.” Presumably, their valuations are based on the future income streams of the TLAs. So yes, I agree that the funds Mr. Mortgage speaks of can’t soak up all the supply, but they can put a value on these things based on expected future income streams.

[quote=davelj]
I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.
[/quote]

Since the banks don’t want this, that makes me think that this index is a very good idea. 🙂

[TheBreeze]

[quote=davelj]
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.
[/quote]

I read his argument as something like this: “The smart buyers out there do not yet see value at the prices these things are selling formarked at.” Presumably, their valuations are based on the future income streams of the TLAs. So yes, I agree that the funds Mr. Mortgage speaks of can’t soak up all the supply, but they can put a value on these things based on expected future income streams.

[quote=davelj]
I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.
[/quote]

Since the banks don’t want this, that makes me think that this index is a very good idea. 🙂

[TheBreeze]

[quote=davelj]
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.
[/quote]

I read his argument as something like this: “The smart buyers out there do not yet see value at the prices these things are selling formarked at.” Presumably, their valuations are based on the future income streams of the TLAs. So yes, I agree that the funds Mr. Mortgage speaks of can’t soak up all the supply, but they can put a value on these things based on expected future income streams.

[quote=davelj]
I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.
[/quote]

Since the banks don’t want this, that makes me think that this index is a very good idea. 🙂

[TheBreeze]

[quote=davelj]
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.
[/quote]

I read his argument as something like this: “The smart buyers out there do not yet see value at the prices these things are selling formarked at.” Presumably, their valuations are based on the future income streams of the TLAs. So yes, I agree that the funds Mr. Mortgage speaks of can’t soak up all the supply, but they can put a value on these things based on expected future income streams.

[quote=davelj]
I don’t have an opinion on his index idea. Maybe it’s a good idea, maybe not. I just don’t know.
[/quote]

Since the banks don’t want this, that makes me think that this index is a very good idea. 🙂

[Author]

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