Friday, November 30, 2007

Not a bad bit of rescuing, huh?

No, it doesn't solve all our problems. No, it doesn't mean those that are over-leveraged (cough SIV cough) aren't still in trouble. But today's news that major mortgage servicers are nearing an agreement on a mass loan modification is tremendous news for senior ABS and CDO holders.

As Calculated Risk and others have reported, in a perfect world banks would do classic loan mods. They'd look at every loan and use a combination of modeling, experience and judgement to decide which loans might benefit from a mod and which are incurable. But in the world we find ourselves in, there just aren't enough people and resources to look through all the problem loans one by one.

I know many in the blogosphere are viewing this with great skepticism. I for one am done with pretending that a good solution is out there. Look, there are enough loans that just shouldn't have been made over the last 3 years to fill a Mon Calamari Cruiser. But nothing we do now is going to change that. No amount of righteous indignation. No amount of finger pointing. No amount of crying moral hazard. And I'm not even saying that the finger pointing is useless, because we need to fix the system that allowed all these loans to be made. The view at this blog was that CDOs deserve a lot of the blame, and by extension, the divorce between loan originator and loan risk holder. We need to fix that. But I for one believe that we need practical solutions to the financial crisis in which we find ourselves. And it sounds like the Hope Now Alliance is a step in the right direction. Even if its name does sound a bit Orwellian.

What we have now, in a sense, are borrowers as a group playing a massive game of chicken with banks and investors. Borrowers, racing toward their reset, are implicitly threatening banks/investors with default. Banks, racing toward reset, are implicitly threatening borrowers with eviction. But really neither wants to make good on that threat.

So what is in both of their best interests is to slow the resets down. Will banks lose money? Yes, because their cost of funds are going up but their loans won't reset as expected. Or put another way, the loans were valued assuming a value for the reset, which now isn't going to happen.

Are the borrowers being bailed out? Yeah, they are. Is there potential for moral hazard here? Yeah, a little. But I really don't think borrowers who were lying awake at night worried about their rate reset are going to come out of this thinking what a great decision that ARM was, no matter what happens.

As for who really benefits: senior holders of ABS paper. Look, the subordinate holders are probably toast anyway. Maybe they get a little bit more in coupon payments. Maybe. But subordinated holders of subprime paper aren't likely to see much in principal payments anyway. But anything that reduces losses, even by a relatively small degree, will improve senior note performance markedly. If you look back on our discussion of senior note recovery, you can see that senior notes can typically handle a large amount of losses before getting touched. That means that if we can take a pool which was going to suffer 40% foreclosures and 20% losses and turn that into 30% foreclosures and 12% losses, that will make a huge difference for senior holders.

Not only that, but the plan will likely extend the timing of losses. This is also hugely important for senior holders. That is because ABS and CDO deals typically amass a over collateralization account over time. That's a sort of slush fund where a certain amount of excess interest gets deposited just in case there are any interest short falls. Well, we know there are going to be interest short falls, so the more that account can build up, the better for senior note holders.

Of course, among the biggest beneficiaries of this will be mortgage insurers and monoline bond insurers. Mortgage insurers get to at least delay the need to pay their policy. The monolines are probably looking at diminished losses, at least on the direct RMBS stuff. The CDO^2 stuff is still in serious trouble, and I don't see how they don't take big losses on this regardless. Note that stocks like ABK, MBI, PMI were all up more than 10% today. Freddie Mac was up almost 20%.'

To reiterate, this plan sure isn't ideal. And we don't have all the details yet, so it might turn out to be less impactful than hoped. But I really think its a step in the right direction.


F-Trader said...

Great stuff as usual.

"we need to fix the system that allowed all these loans to be made."

Is it the system? Or is it just inflationary expansionism finding yet another crack to fill with overconfidence and mal-investment?

Anonymous said...

How will the mortgage originators taking part in the "New Hope Alliance" enforce terms on the third-party investors who hold the majority of the mortgage debt? Presumably any resolution will apply only to loans held directly by the originating organizations (Citi, CFC, etc) and not to resold loans.

Anonymous said...

Anything that would draw out the problems and dampen the panic would, I agree, be good for the mortgage insurers and other "market participants." But I don't understand how this program would be so great for the senior ABS and CDO holders. What am I missing?

I presume that these tranches, especially the senior tranches, were priced based on some projection of incoming interest proceeds. But delaying mortgage interest rate resets would hit the incoming interest. If we're talking about resets from low teaser rates to high subprime-priced rates, the hit to interest would be enormous. So where would the money come from to build up that "over collateralization account" that you mentioned?

What would these tranches be worth with only a trickle of interest coming in? Or, could the monoline bond insurers be called on to make up the "missing" interest?

Those lucky enough to keep mortgage payments at teaser rates would be in a position similar to tenants in rent-controlled apartments. They would have an incentive to stay in those houses as long as possible, even sublet them if they needed to move. This would tie up capital in bonds which pay very low interest (unless the difference were made up by the monolines or the government). But this delay would not necessarily help them eventually pay off the principal, especially if the "missing interest" were added to the principal in an option ARM fashion.

Personally, I think most of the monoline bond insurers are nearly in run-off mode, and they will stay there for some time. I suspect that the will remain in effective run-off, regardless of rating agencies' decisions or of moves to shore up capital or reinsure risks. So how much would they be worth in run-off? The structured finance business looks like it will be stuck in the doldroms for quite a while. For muni insurance, the news flow is just horrible for most of the monolines. They've been tainted by the risk of structured finnce. One muni bond emitter after another has foregone insurance, or chosen FSA (even when FSA was not the winning bidder!). An interesting article noted that 64 blocks of bonds have been reinsured this year in the secondary market, compared to 8 blocks at this time last year. Of those 64 blocks, FSA reinsured more than 50 blocks which were already guaranteed by Ambac and FGIC.

Having resisted the sirens of structured finance, FSA is set to clean up. There may be new entrants into the muni insurance market. CIFG, with strong financial support, may also gain muni market share. (CIFG provided Natixis with less than 2% of its profits. Natixis is listed in Paris, but is 2/3 owned by two large unlisted French banks. They are relieving Natixis of its CIFG problem by taking the monoline into their own capital structures. It seems that Natixis has bigger fish to fry -- press reports mention $9 billion of SIVs.) Bailing out CFIG made sense for the French banks (CIFIG represents a relatively small problem for them, they have reputations to maintain, and they probably wanted to support the stock price of Natixis). So, is anyone going to play "sugar daddy" for Ambac or MBIA in a similar way?

By the way, you are writing terrific stuff here, and I appreciate your blog as well as the great comments. I'm learning a lot here.


Unknown said...

Alan, what is being negotiated is 1) a set of template criteria to identify designed to pick out the class of borrowers who fit the description of somebody who would wind up in foreclosure at the adjusted rates but not the original rates and 2) an agreement from lenders, servicers, and securitizers to extend the original rates for just those borrowers for some specified number of years. People who don't need the exemption to avoid foreclosure and people who are headed for foreclosure anyway won't get the exemption. Naturally, there will be some mistakes and abuses, but since transaction costs in foreclosure are so high, everybody can come on board with the correct premise that a useful arrangement helps them in the aggregate. The concept is kind of clever because borrowers will need to prove some appropriate level of income in order to qualify for the exemption.

viking said...

Anonymous asked the 64K question--this can only be applied to loans that have not been securitized.

If the loans have been securitized, freezing the teaser rates is the SAME THING AS DEFAULT, due to the lack of interest income.

When this is all said and done, this bailout will help a miniscule amount of borrowers, not enough to impact the BIG PROBLEM, and will cause as many problems as it purports to solve.

Anonymous said...

AI: If the taxpayers are going to be expected to absorb part of the cost of this-- bailing out Wall Street, bailing out banks, or directly bailing out homeowners -- then why doesn't everyone get a check?

I was responsible, I pay my bills on time, I bought a house I was sure I could afford. Heck, I even took the time to read the mortgage agreement before I signed it. I asked questions about parts I didn't understand.

So why don't I deserve some money?

What kind of capitalist runs around subsidizing the foolish and the irresponsible at the expense of the people who played by the rules?

Capitalism according to the bailout crowd:
- If someone takes out a loan they cannot afford: reward them
- If a CEO lays off the risk management department to cut costs: give him a nine figure severance package
- if a bank fails to exercise their fiduciary duty: bail them out

But if someone plays by the rules and lives frugally: PENALIZE THEM!!!!!

Anonymous said...

None of the New Hope Socialists Alliance supporters have explained where the mortgage industry is going to get qualified people to examine each loan and decide whether a borrower truly is in trouble, or just claiming to be in trouble to get a free ride.

If there wasn't massive fraud in the appraisal process, there will be now.

Most of the people who were effected by Huricane Katrina never got the govt help they were supposed to: but hundreds of people who had never even been to New Orleans got subsidy ATM cards from Uncle Sam/taxpayers. Somewhere out west, there is STILL a huge warehouse filled with ice that is supposed to help the people of New Orleans.

Let me guess: as the dot-com suporters always said: This time will be different!!!

Anonymous said...

As a member of the cohort of citizens who chose NOT to overextend myself with mortgage and credit card debt, my only message to all the upside-down, overextended, in-over-their-heads borrowers out there pining for a government bailout: "Don't shoot, let them burn" by a GI in Saving Private Ryan

Anonymous said...


I wish to address your first comment directly.

Capitalism does not work. It is the economic equivalent of the French aristocracy before the revolution, and you...well, you are the equivalent of the person pulling the lever on the guillotine.

Capitalism does not work.

Watch the course of events in the US over the next two years and tell me if you disagree.

Anonymous said...

Permit me to add something to what I addressed to Gramps.

I have now had the opportunity to depend on health insurance in the United States and in France.

There is a great difference in the two systems. In France, the position of the French government is that there will be no one in the country who lacks health insurance. In the United States that is not the case, witness the 40 to 60 million uninsured.

Putting aside the meaningless drivel that universal health insurance is impossible, etc. (after all it is the current system in France, and medical care is better in France than in the United States, and France is in better economic condition than the United States), put aside the drivel and ask yourself the question:

Which country would you want you and your family to live in?

Of course, in a capitalist system, each of us would pay for our own health care out of the profits of our capital.

Accrued Interest said...

Gramps: I don't know where taxpayer money comes into this.

Others: The question of whether securitized loans can legally be modified in this way is a good one, which I don't know the answer. I will caution readers to remember that the law is often ignored when ignoring the law is in every one's best interest. What about all those money markets getting bailed out by banks? Technically they've broken recourse. And if the money market has recourse, then it needs to be counted like its a deposit. But everyone ignores this.

However, some structural notes on RMBS/ABS. Both these instruments pass through interest to bond holders. So if the interest payments are modified to be less than they'd otherwise be, bond holders just get less. There isn't a "promised" rate, so paying less in this case would hurt bond holders, but not as much as foreclosure would hurt.

CDOs are a little more complicated, because bond holders have been promised LIBOR+X where X is some fixed spread. If rate resets (lack thereof) are such that they can't make LIBOR+X, then that will cause losses in the tranches. Less than would have been under mass foreclosures tho.

Unknown said...

"The question of whether securitized loans can legally be modified in this way is a good one, which I don't know the answer. I will caution readers to remember that the law is often ignored when ignoring the law is in every one's best interest."

Everything I've read so far on the proposal suggests that nobody's property/contract rights are being taken from them in any agreement - participation is voluntary - and no large amount of govt. money is going to any "bail out", though the govt. may pay for some overhead expenses like communication or limited service support. The *goal* - I emphasize goal because I'm not here to argue what the effectiveness will be - is to carve out a class of loans where changing the interest schedule in favor of the lendee will likely avoid a foreclosure that would otherwise have occurred. The lenders/securitizers/servicers etc. agree to go along voluntarily in most cases because it is financially advantageous to them to do so because of the high transaction costs of foreclosing and reselling property. The idea is that they also save over trying to do workouts on a case by case basis because the sheer volume of distressed loans exceeds the servicing capacity that is available at reasonable cost.

Anonymous said...

As long as someone has to look over the borrowers files, I suggest one more check... for fraud. If you are in over your head due to fraudulently stated income then no "NEW HOPE" for you ! Come back 3 years.

Anonymous said...

AI: the taxpayer is directly involved in bailing out the stupid, because the Secretary of the Treasury is twisting the rules to help solve what is a private issue.

Anonymous (8:27a and 8:33a) ... huh?

You couldn't pay me to live in France. The food is awful- yes I know all about the Michelin star thing, but you over cook food then drown it in fatty, heavy sauce. Stale bread. Portions are intended for midgets. Ask your neighbors in Italy for cooking lessons. And talk about a major PR problem -- the only time France is in the news is when they go on strike (seems like always?) and when they are stabbing one of their "allies" in the back. Germany and Canada were both very opposed to attacking Iraq -- but only France went and actively campaigned against us. You don't have to support your friends when you don't agree with them, but you shouldn't go stab them in the back either. That's the reason why Americans still like and respect Canada, but we hate France.

As for your universal health care diatribe ... not sure what that has to do with this blog, AI's most recent post, my reply, or anyone else's reply. Do French schools teach about identifying the major subject of a writing? Everyone else here was talking about mortgages and credit crisis and so forth.

Quality of health care? I don't know about James Hymas' situation in particular, but after living in upstate NY for many years, I can tell you that wealthy Canadians cross the border by the bus load to get access to our health care system. If cost is not an issue, our system is better than almost anything on the planet -- Thailand or India may give us a run for our money soon if they don't already. But France? If money is no object, no one would think of going to France for a complex surgery.

When the late King of Jordan needed heart surgery, he flew over the butchers of France and sought care at the Mayo Clinic. Cost is obviously not an issue for a king, so when he wanted the best he came to the U.S.A.

As for less complicated care, maybe you should go to the drugstore and take care of yourself? What sort of loser needs a government or their mommy to take care of them for every little scrape?

And on "universal care" itself -- this is mostly an argument of the ignorant and uneducated. The U.S. doesn't have a quality of care problem. If you disagree, go back to France-- once less lazy socialist clogging our emergency room.

We do have 60 million or whatever number uninsured, but that really isn't the issue. Anyone who wants to buy insurance is able to, there is no law (or anything else) stopping them -- it is strictly a problem of cost. Small businesses canceled insurance because they couldn't afford it, not because they disapproved of the quality. Everyone in the U.S. is already able to buy insurance, but they cannot afford it.

Now Mr. Socialist: take a look at the bureaucracy we call "Uncle Sam". This group of idiots, Democrat and Republican alike, think nothing of paying billions for a single airplane. Ten thousand dollar coffee maker? Wave it in! A $300million bridge to nowhere Alaska? Lets get two. Dozens of books have been written about absurd government spending -- without even scratching the politically controversial stuff.

Now what sort of Frenchman would suggest putting an entity like the U.S. government in charge of a project to control costs?

If you like Socialism so much, move your butt back to France. You are not welcome here.

Anonymous said...

Capitalism does not work.

It does not work because nobody can be trusted to regulate the money supply. The crooks always gain control.

Anonymous said...

AI: I got off on a tangent there since I absolutely do not want to be likened to a Frenchman or to a socialist.

To finish answering your concern, the Secretary of the Treasury is supposed to work for taxpayers, not banks -- its not clear from an economic standpoint that he should be working on this mortgage problem, its politics that has him involved.

More importantly, this "New Hope" nonsense isn't going to work "as is". There are a lot of homes / mortgages that are simply underwater. Assuming historically "normal" house appreciation (4-6%, not the 15-20% we had the last few years) -- these houses will remain underwater for many years to come... irregardless of what interest rate the bank charges, why are these people going to pay on the house for a decade or two just to break even? How is that any better than renting? You don't need an MBA to realize your seven year bankruptcy credit hiatus will be long over before your house price catches up with your mortgage.

In other words: somewhere, somehow, somebody is going to be taking a very, very big loss. Calculated Risk had some interesting stuff comparing the current situation to the S&L crisis in the 1980s (when banks made foolish loans against overpriced collateral -- deja vu). If the current situation is the same size, as a percent of GDP, you would expect losses to be around $800 billion. Wall Street wrote off $45 billion -- $750 billion to go. Who else besides "the government" (aka the taxpayers) is going to come up with that? We can argue whether a bailout is a good economic idea or not, but politically something is going to happen.

And finally, lets talk about the Helicopter pilot we have at the Fed. I know someone is going to start quoting CPI at me (even though the BLS says CPI is NOT an inflation measure) -- but the cost of living for many people is going up by several multiples of CPI.

Those on a fixed income and those with substantial savings -- are seeing an erosion of our purchasing power because interest rates are well below the rise in the cost of living.

Political rhetoric aside, Bernanke and Paulson (and Greenspan) have an agenda to devalue the dollar. If you don't like calling it inflation, give it a more positive "spin".

But don't lie to us and say that our cost of living is going up only 2.5-3.0%

Anonymous said...

Just curious if anyone is looking at the effect of collapsing interest rates on corporate pension obligations? Just thought of that when I was ranting about people on fixed incomes...

Lower rates means the future obligations are now discounted at much lower rates -- ie the obligations got a LOT bigger in the past 4-5 months.

This is another reason why I have argued against lowering rates to solve what is not IMHO a liquidity crisis. "Easing credit" and dropping rates is not the cost-free solution that its advocates like to portray.

Anonymous said...

AI, I'd be interested in knowing if you have any other comments regarding the objections brought up within the Naked Capitalism piece on this rescue. Note that Tanta replied in the comments..


Unknown said...

Thanks for the link to the Naked Capitalism discussion. I googled for more detail about the Mike Castle proposal that has people concerned, but didn't come up with much. However, a moment's reflection should convince anyone with common sense that the proposal can't possibly be to remove liability for loan servicers with respect to *any* sort of loan modification (especially in situations where their interests may be different than the loan holders). So more detail is needed to know whether the various concerns are valid.

Anonymous said...

As far as the legal implications are concerned, many of the comments are either misguided or accuse involved parties indiscriminately. As AI mentioned, senior bondholders would benefit tremendously from improved cash flows, but junior bondholders would see little to no improvement. If loan mods were to go through en masse, junior bondholders could conceivably argue that the loan structure they entered experienced material changes, leading to an event of technical default. Keep in mind that any large-scale action will be hindered, at least initially, by incongruous expertise regarding the performance of modified loans, so it may not be immediately clear whether generic loan mod prescriptions will benefit or hurt different investors.

The fight is essentially a free call option for junior lenders. If they convincingly argue that a negative covenant had been breached, they may benefit immediately from redirected cash flows. If they fail, their downside would only be the legal costs incurred.

Unknown said...

is it clear or controversial that the Paulson plan will be relevent to those mortgages who have NOT been securitized? Expert opinion please...
If so what proportion of mortgages are still on the balance sheets of the banks who originated them, and do they have the same quality characteristics as the securitized loans? Thanks

Anonymous said...


OT but I thought you might find this interesting given your previous posts on the topic.

Accrued Interest said...

On Naked Capitalism: I had already read that piece. Both that site and Calculated Risk are great blogs, among the few I actually read regularly. I just disagree here. I'm not really sure why Tanta is against this plan (I haven't read CR in several days so I'll have to check in over there). But the plan SOUNDS very similar to something she proposed herself about 2 weeks ago.

On Middleton... I think he's being REAL aggressive about losses as well assuming that market cap has much to do with this story. The market cap reflects expected losses, so you can't say "Losses will be X and market cap is only Y!" when the market cap is already a steep discount to book.

Anonymous said...


You have a great blog, but I think you're off track on this one.

The essence of a credit cycle is that it creates deflation in the underlying collateral. The first reaction to this deflation is to postpone liquidation in hopes that prices will turn up. Of course, this tactic has the opposite effect: delay the onset of market clearing prices, delay the eventual upturn in the market. There are countless examples of this, most notably Japan.

The crux: anything that delays liquidation exposes senior holders to lower recoveries as prices fall. Foreclosures are a far better result for those tranches as severities are still low enough to leave them unscathed. How much longer will that be the case? If I were a AAA holder, I'd want those houses sold as quickly as possible.

Anonymous said...

If Mr. Paulson wants the public to believe that his gross interference (Super SIV Entity, Freeze loan rates, etc.) with the markets is to help homeowners and to achieve other noble causes, but not to bail out his banker buddies and Wall Street fat cats, he can do it.
Simply make it a condition of any New Deals (rate freeze, Entity) he is brokering that the CEOs, principal officers, and board of directors of the banks, Wall Street brokerages, lenders, etc who caused this crisis be fired. Not only fired, but fired with no golden parachute.

This group of pirates who raped and pillaged the home mortgage industry and the credit markets must be removed from having anything to do with Mr. Paulson’s New Deal. Even if these New Deals are voluntary and do not involve taxpayer $, Mr. Paulson and the fed agencies have no business conspiring to keep the thieving pirates in business. The first requirement for any government sanctioned New Deal or Grand Bargain must be to throw out the whole thieving command and control of banks, brokerages, and lending institutions.

Mr. Paulson, the public calls your bluff. Show that you can punish the guilty while saving the innocent. The two are not incompatible. In fact, cleaning out the guilty is part of restoring public confidence in the banking system.

Anonymous said...

tom a taxpayer... AI has already decreed that there is no tax money in Paulson's plan. AI has also said that this is a liquidity crisis, and the Fed needs to pump massive amounts of new money into the system -- even though none of the first 75bp went toward the causes that supposedly necessitated the cuts.

Opinions to the contrary will be ignored

Anonymous said...

This is the "gramps" from a few weeks ago; I was traveling and I see someone else is now using the gramps nickname. Ain't the internet grand?

AI -- speaking of the naked capitalism piece... I am curious on your thoughts about the "repudiation of a contract" idea.

You probably remember a couple years ago when the Supreme Court decided to allow bureaucrats in Connecticut to seize several homes using Eminent Domain. The homes were lived in and maintained, but the bureaucrats decided they could get even more tax revenue if those houses were replaced by expensive condos... The legislators in the Great State of "Corrupticut" quickly changed the law going forward (albeit with a little prodding from the angry mobs outside) -- but the point still remains that the supreme court of the land basically ruled that private property isn't really any such thing.

And now, a whole band of people are separately making proposals to rewrite mortgage contracts in arrears (Paulsen, Congress, various state govts).

If you want to argue that some mortgage assets are good, I think you need to establish that property laws and contract laws are not written in pencil -- subject to change whenever it suits the economic elite.

The law is not written in stone -- but the willingness of the United States (government AND citizens) to ignore the law whenever it suits them should be a real warning to all our creditors.

China may soon learn that all the bonds it owns are just "odius debt" (see the article from Rob Arnott and others)

Accrued Interest said...

I'm really not sure about the legal aspect of this deal, specificially NC's repudiation concept. I'm not a lawyer and I'm not going to pretend to be. I will merely point out that there may not be any "loser" party here to complain.

This is similar to my money market example, where since there are no losers, no one complains.

And I think many market commentators claiming that senior holders lose with mods are using 2005 logic. In 2007, most RMBS pools have already or soon will tripped the loss trigger, so senior holders are getting all cash flow.

Gramps: I can't believe you had your blog ID stolen! Whoever is posing as gramps, pick a new handle or stop commenting here.

Anonymous said...

David Pearson's observation about continuing negative HPA and the effects on later liquidations vs. now seems particularly acute. Any thoughts there AI?

Consider the volume of loans going south now prior to any resets, the number of borrowers that will actually meet the criteria and the time and resources required to bring this program online and then individually qualify borrowers with some actual scrutiny...and the more expansive the criteria the greater the resource requirements and the likelier some significant backlash develops.

Whatever size that pool of qualified participants is, do you think that HPA is going positive some time soon? Or how many folks who are underwater on their mortgage will want to continue to pay as what appears to be increasingly adverse macroeconomic conditions develop?

Finally, what impacts on future mortgage lending and its support or lack thereof for HPA this will have?

Anonymous said...

By way of rebuttal to your overly optimistic view, I'll just post Winter's take on the issue as it seems complete:

"There is a new spin at hand called the New Hope Alliance described in this WSJ article to try and offset this. This approach is largely implausible for several reasons. Hundreds of billions in mortgages have been securitized into MBS (mortgage backed securities), and are not owned by the servicers mentioned in the article. Changing the terms of mortgages in effect lowers the coupon on the security. This of course would have the effect of lowering the value of MBS. A MBS of say $1 billion might have an undetermined number of holders, and rarely if ever just one. How exactly does the New Hope Alliance secure the agreement of ten or fifteen MBS holders to lower coupons and terms. This could include a foreign central bank or two, and most certainly foreign financial institutions. How exactly does the US Treasury apply “suasion” against a foreign firm? Credit insurance is also put on against default and against altered conditions. If somehow some MBS were restructured under new terms this would in turn trigger a wave of claims against the credit insurance written against this securities. Would the insurers (if even still around) agree to pay these claims? This scheme as it applies to the mountain of MBS in the marketplace is just too much of a tangled web to ever be seriously implemented."

IMHO, Paulson's timing on the announcement was a little too cute to be take seriously. Just in time for fiscal year-end and protection of Wall St. bonuses by juicing the markets generally and the financials specifically. AI, you didn't actually fall for this stunt, did you?

Anonymous said...


You write, "In 2007, most RMBS pools have already or soon will tripped the loss trigger, so senior holders are getting all cash flow."

I believe this is a 2005 view of the world, one in which credit conditions are single "snapshots" rather than moving video.

The video playing has economic conditions deteriorating as a result of the credit crunch, whose full extent or effects have not yet been felt.

In this type of situation, the only thing AAA holders can (mildly) rely on is current home prices (as opposed to future cashflows). Better to take advantage of these home prices as much as possible (i.e. max out foreclosures) then depend on that cash flow stream.

In short AI, when the price of something is falling, better to sell now than later. What's wrong with that logic?

Accrued Interest said...

David: Unfortunately for this conversation, fortunately for my career, I haven't personally bought any subprime RMBS paper. Ever.

So the unfortunate part is that I don't have a nice list of them to say which have triggered and which haven't. All I can tell you is that traders have told me that most are either right on their loss trigger or already tiggered.

Now something worth mentioning is that IF the monoline insurers did a better job with credit analysis, its possible that their pool are performing better than average. The flip side of this is maybe their pools haven't triggered. So ironically, their better credit work could be a negative.

Appreciate all the comments. Sorry I can't respond personally to all of them. Interesting how few in the blogosphere like this plan. I don't quite understand how this plan is markedly different than one Tanta suggested before Thanksgiving:

Now she seems negative on Paulson's plan.

One last thought on David's "sinking price" idea. Part of the benefit from this plan maybe exactly that it limits secondary supply of homes and spreads it out over time. Why wouldn't that result in more stable home prices? Let's say that we need to see 20% real decline in homes to get to the "right" level. What if this plan causes 5% real decline over 4 years instead of 10% over 2 years? Is that so bad?

Another thought that just occured to me. If the interest paid out on a pool is artificially held too low, but the debt securities sold on that pool are set against LIBOR, then there is going to be an interest short-fall. It might be that this alone causes triggers sending cash flow to the Senior holders. At least that would be true in most CDO deals, which typically have an interest coverage ratio test.

Robert said...

"One last thought on David's "sinking price" idea. Part of the benefit from this plan maybe exactly that it limits secondary supply of homes and spreads it out over time. Why wouldn't that result in more stable home prices? Let's say that we need to see 20% real decline in homes to get to the "right" level. What if this plan causes 5% real decline over 4 years instead of 10% over 2 years? Is that so bad?"


Yes, but doesn't that assume that other trapped holders don't seek to front run the financial institutions? All of the other trapped holders who are not delinquent (but who are experiencing negative HPA) are going to move their property to market as soon as possible. Work-outs will just put the financial institutions at the back of the line. 5% decline a year (even over 4 years) seems optimistic should the public start truly panicking.

Accrued Interest said...

Well, at least the banks don't think that's how its going to play out or they wouldn't agree to it.

I mean, I think this is a good plan. But I'm sure not sitting here telling you its perfect. As I said in the post, we're in "lesser of two evils" territory now. We passed "everything is going to be fine" several parsecs ago.

Anonymous said...

Can someone explain how this pricing fix can be implemented if the vast majority of subprime loans have already been packaged and sold in CDOs? It seem not possible since the loans are already off the originators books.

Anonymous said...

Great post,
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