The Oil Drum

12 comments on The Round-Up: June 29th 2007

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HeIsSoFly on June 29, 2007 - 2:52pm

Get informed, guys, this will hurt you too. Stop focusung on the housing bubble, it's much bigger than a few buildings.

The roof is caving in, with an earthquake approaching fast. That rumble you hear is just the start.

As Bloomberg states below, Wall Street is lying and hiding all they can. The reality now is that millions of private investors and institutions (pension funds!!) hold hundreds of billions of dollars in securities and other paper, that have already lost 25% of their value. Thing is, nobody knows it yet.

Nobody? Not quite. Moody's and Fitch do. But they ain't telling, and that is a risky move. If and when news leaks out that they have been selling off their assets while lying about the ratings, there'll be lawsuits from here to kingdon come, and big names will fall. Bear Stearns is just the first.

S&P, Moody's Mask $200 Billion of Subprime Bond Risk

Standard & Poor's, Moody's Investors Service and Fitch Ratings are masking burgeoning losses in the market for subprime mortgage bonds by failing to cut the credit ratings on about $200 billion of securities backed by home loans.

The highest default rates on home loans in a decade have reduced prices of some bonds backed by mortgages to people with poor or limited credit by more than 50 cents on the dollar and forced New York-based Bear Stearns Cos. to offer $3.2 billion to bail out a money-losing hedge fund. Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the ratings criteria in place when they were sold, according to data compiled by Bloomberg.

That may just be the beginning. Downgrades by S&P, Moody's and Fitch would force hundreds of investors to sell holdings, roiling the $800 billion market for securities backed by subprime mortgages and $1 trillion of collateralized debt obligations, the fastest growing part of the financial markets.

``You'll see massive losses from banks, insurance companies and pension managers,'' said Joshua Rosner, a managing director at investment research firm Graham Fisher & Co. in New York and co-author of a study last month that said S&P, Moody's and Fitch understate the risks of subprime mortgage bonds. ``The longer they wait, the worse it's going to be.''

PS I'll post this on the drumbeat as well

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Stoneleigh on June 29, 2007 - 3:23pm

Thanks again HISF - we are indeed very close to the beginning of an exceptionally serious financial crisis. Rating agencies will hold off on downgrades for as long as they can in order not to lose business (note the conflict of interest), but will eventually be forced to downgrade.

As with Enron, the downgrades will be too late to be of use and will probably precipitate a rush for the exits. It will be a very dangerous time to trade as executing trades will probably be difficult to impossible during periods of rapid decline, and counterparty risk would be increasing all the time. In other words, getting out at the top will not be possible for many institutions, let alone for ordinary people.

As you noted before, pension funds are holding many of the 'assets' that won't be able to be sold at any price - the so-called 'toxic waste' CDOs among other things. In chasing yield they have taken on staggering amounts of risk they didn't understand. Ordinary people will pay the price.

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HeIsSoFly on June 29, 2007 - 3:42pm

Tanta covers the Bloomberg article too. It's a bit long, but I'll post the whole thing anyway. Hope that's OK. She's interesting.

Bloomberg's Numbers

Hat tip to Ministry of Truth for bringing up this startling Bloomberg article, "S&P, Moody's Hide Rising Risk on $200 Billion of Mortgage Bonds." (How much did Fitch pay to get out of the headline?) As our fine commenters have noted, that's an amazingly bearish headline for Bloomberg. It's also a startlingly bald accusation: there's a line between asserting that the rating agencies are not downgrading bonds as fast as some observers think they should, and asserting that they are "hiding rising risk," without the usual "may be" weasel. Bloomberg just stomped right over that line, which suggests to me that tempers have become a bit short:

Standard & Poor's, Moody's Investors Service and Fitch Ratings are masking burgeoning losses in the market for subprime mortgage bonds by failing to cut the credit ratings on about $200 billion of securities backed by home loans.

"Are masking burgeoning losses"? That's even worse than "hiding rising risk." One rather hopes that Bloomberg has its numbers right.

This particular blogger is not sure she understand's Bloomberg's numbers. We get, in order:

"$200 billion of securities backed by home loans" should have their ratings cut.

"Almost 65 percent of the bonds in indexes that track subprime mortgage debt don't meet the ratings criteria in place when they were sold"

"the $800 billion market for securities backed by subprime mortgages"

"$1 trillion of collateralized debt obligations, the fastest growing part of the financial markets"

"estimates that collateralized debt obligations . . . will lose $125 billion"

"25 percent of the face value of CDOs is in jeopardy, or $250 billion"

"asset-backed bonds, securities that use consumer, commercial and other loans and receivables as collateral . . . which includes mortgage securities, has doubled to about $10 trillion"

"the $6.65 trillion in outstanding mortgage-backed debt"

"Investors snapped up $500 million of the securities [CDOs] globally last year"

"subprime-related debt made up about 45 percent of the collateral backing the $375 billion of CDOs sold in the U.S. in 2006"

"Of the 300 bonds in ABX indexes, the benchmarks for the subprime mortgage debt market, 190 fail to meet the credit support standard . . . Most of those, representing about $200 billion, are rated below AAA"

OK. So we know right off the bat that item 9 has to be off by an order of magnitude if item 10 is true. If the true size of "the market" of subprime-backed mortgage bonds is $800B, that makes it 80% of the size of the CDO market, 12% of the size of the total MBS market, and 8% of the size of the total ABS market.

If $375B of CDOs were sold in 2006 in the U.S. and 45% of that involved "subprime-related debt," and we assume just for fun that "subprime-related debt" means subprime-backed MBS and that CDOs invest mostly in subordinate tranches (because we aren't sure otherwise where they get enough high-yield to make their numbers work), that suggests that there were at least $169B of low-rated tranches of subprime securitizations available to resecuritize into a CDO last year. That would be just over 20% of this "total market" of $800B. That would imply a pretty thick layer of subordination. I'm thinking that either those CDOs are buying higher-rated paper than we've been led to believe, or else, possibly, "subprime-related debt" includes things like credit default swaps on subprime paper, which implies that brains will explode before we'll be able to line up bond balances on one hand and the notional value of CDO holdings on the other.