Time for Selective Buying of Mortgaged Backed Securities?
Interest-Rates / Credit Crisis 2008 Sep 19, 2008 - 08:12 AM GMTBy: Andrew_Butter
What's the difference between a TV rating and a bond rating? Answer: The TV rating is audited.
Putting the incompetence of the rating industry in USA and Nadeem Walayat's expression Tulip Backed Securities to one side, my granny always used to say, "Where there's Muck there's Brass"
Investment opportunities happen when the price goes down less than the value. Well there is plenty of muck hitting the fan these days. So now we aren't allowed to have any fun shorting banks anymore, where's the brass?
In July, Merrill Lynch sold $31 billion of "toxic securities" for 22 cents on the dollar. Presumably that deal helped make Merrill saleable (or bailable)? Apparently Lehman held out for more, but look what happened to them - or perhaps it was Lehman that bought those tulips?
At around 22 cents might there be value to be had? In any case, by now there ought to be some "willing" sellers (or liquidators) who are beginning to understand the full reality of the collective stupidity. And one wonders what to do with one's loose change these days - put it in the bank? Umm...
After all one would assume that a good proportion of those securities were at their core collateralized by actual houses. Or would that be too much to ask?
If the houses actually exist (not a bad idea to check), then say for example:
• Little-Joe and Mary-Lou bought a house in California for $600,000 with a 100% mortgage.
• A rocket scientist packaged a thousand or so of such loans into a mortgage backed security, paid a "team player" in a Big Dick accountancy company (handsomely) to sign off on the paperwork, paid a "team player" ratings agency (handsomely) to stamp AAA all over the place, and then sold the thing to some dumbo mark for what...?
Add on the NPV of the interest payments...let's say $800,000 per unit? Or did he mange to sell it for more? It's hard to know, some of those con-men are (were) pretty slick, natty suits too.
• Then when the teaser-rates ran out Joe sent the keys back, now the house is worth say $350,000 (with proper marketing). Next year (it's California remember) it could be worth $300,000.
But that's still 30 to 40 cents on the dollar, or did I miss something? If those are about the numbers then 22 cent's or thereabouts doesn't look too bad?
Particularly since a few things have changed since July. Notably the US Treasury has committed to keep printing money until Fannie and Freddie are out of the woods, and it looks they are going to have a stab at printing enough money to make good all those CDS's...ha..ha!! Quite soon the Weimar Republic will have nothing on these guys. Talk about inflating your way out of a corner.
Of course they will deny it, but it looks like the Fed is going to keep interest rates significantly lower than inflation until this is over. That's the only way to re-inflate or stabilize house prices, the ultimate collateral for those silly bets.
Why does the ratio of interest rates to inflation matter?
If you calculate inflation the way it was done up to 1987 (before they started cooking the books to make it disappear) it works out a lot more than what was reported from 2001 to 2006 - see Mike Shedlock in Market Oracle 3 rd Sept.
Plot that against the level of over-pricing or under-pricing (Market Oracle 13th Sept 2008), you can see why:
If: House Price Inflator = Average past four years: Inflation 1987 - Base Rate
Base Rate
That's a nice correlation that explains the madness of the Greenspan Boom perfectly. There is no correlation when interest rates are set above the 1987 method of calculating inflation, which makes sense.
So what does that mean?
If that model works in the future they are going to have to print dollars and pump up inflation for two or three years before house prices start to shift from the trend-line (10% to 20% down over the next two to three years).
• If inflation is about 4% and the base rate is 2% the there could be a nice sharp bounce of even 20% in 2012 (after the drop of 10% to 20% from now). And with the overall trend-line level of incompetence it's a pretty sure bet they will not know when to stop.
• Drop the rate to 1% and nurture inflation up to 5% and the drop won't be more than 10% (nominal) and the bounce could come by 2011.
One thing is sure, they shouldn't be shy about setting the base rate that far below inflation, it's nothing new, it would be hard to do that better than Mr. Greenspan did.
The only difference is that last time it was a mixture of greed and incompetence that persuaded them take a hammer to the engine of the US economy.
This time around it's a fight for survival.
Short term until they fix the regulation (if they ever do) they have no choice.
(There is an explanation for how to fix it in my essay in Market Oracle of 13th Sept, apart from making sure market participants aren't allowed to use long words they don't understand (like value), or to shoot themselves in the foot, basically the trick is to get the regulators to substitute their seratonin-uptake-inhibitors with amphetamines),
The economy will survive, getting housing (and everything else) priced correctly is good for the economy long term, whether the financial system as it is now will carry on, is another matter. But like the good Baron Rothschild said, when there is blood on the streets there are deals to be done.
For the careful shopper, the size of the stink is a signal that perhaps there is value to be found. Just remember to hold your nose and pick your carcass carefully.
By Andrew Butler
Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
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