by Anonymous on 6/24/2007 08:17:00 AM

naked capitalism has a nice post up this morning that combines all of my favorite themes: models, valuations, risk management, and what the hell is the matter with the New York Times today?

I am not a Times Select subscriber--I get most of my useful business analysis from Opera Weekly--so I don't spend enough time picking on Gretchen Morgenson since she went behind the pay wall.

But Yves is out there doing the heavy lifting:

Back to Morgenson. She got a very important issue wrong:

Officials at ratings agencies have said in the past that their ratings reflect their estimates of future performance, not market pricing. So the agencies are also marking to model.

Ratings agencies are not Bloomberg terminals. They provide ratings.

There aren't many people who are more cynical than I am about the rating agencies, but a whole lot of people need to memorize those last two simple sentences. We can argue all day long about whether these bond ratings are sufficiently stress-tested, whether downgrades are too slow, whether the rating agencies conflate "collateral problems" and "structural problems" in their analysis. The whole sorry issue of their fee structure and non-arm's-lenth relationships with the bond underwriters could keep us talking for weeks. But if you want to tell me there's an "observable market rating" to which the agencies should be "marking," you'll have to tell me who writes your prescriptions.

To suggest that the rating agencies are "marking to model" is mind-numbingly dimwitted. This is just like The Great FICO Uproar: everybody wants to get all fired up about whether FICO scores are "inflated" or "manipulated" or what have you, as if FICOs are somehow supposed to be something other than just scores produced by a model.

News flash: There are good models, bad models, and ugly models. There are transparent and opaque models. There are stress-tested and untested models. They're all models. And if they're claiming to model probability of principal loss via default of the underlying collateral, that number you get at the end isn't a dollar price. The number you get at the end could be an input into a pricing model, to be sure. But would you really want to claim that an apparent failure of your pricing model is caused solely by one credit model-generated input failing to correlate to a future market price? If so, you aren't using a "pricing model." I don't doubt that there are some stupid investors out there who have been acting as if a certain credit rating--on a mortgage loan or a CDO tranche--guaranteed a certain market price. But the technical financial-accounting term for those people is "doofuses."

Maybe we could just have a moratorium on anyone using the phrase "mark to _____" for rhetorical flourish until we all get a little clearer on the concept.

by Calculated Risk on 6/23/2007 04:32:00 PM

Floyd Norris at the NY Times writes: Homes Sell. Homes Don’t Sell. Builders Still Build.

And here are the charts from the NY Times story.

THE American housing market, as measured by home-building activity, is falling at the most rapid rate in decades ... [and] the weakness will last while builders seek to sell homes they have already built.

It is unlikely that home starts will turn up significantly until that inventory is significantly reduced.

However, it isn't just the inventory of new homes for sale that will impact the homebuilders. Existing homes are a competing product for new homes, and the record inventory of existing homes for sale will also pressure home-building activity.

Click on graph for larger image.

This graph shows the year end inventory levels, since 1982, for new and existing homes. (2007 numbers are for April).

The second graph shows annual starts vs. total housing inventory (new and existing homes).

Look at the previous housing bust in the early '90s. Starts picked up as inventory fell in '92, and starts continued to increase in '93 and '94 as total inventory fell further.

This time the total inventory is so high that starts will probably not pick up until the total inventory levels have fallen significantly. And, with tighter lending standards, demand will probably continue to fall too. Instead of looking for when home-building activity will pick up, perhaps we should be looking for the next decline in housing starts.

More data will be available this week, as the existing and new home sales reports for May will be released on Monday and Tuesday, respectively.

by Anonymous on 6/23/2007 04:18:00 PM

Bear, the two of us need look no more
We both found what we were looking for
With a loan to call my own
I won’t pick up the phone
When Merrill Lynch calls me--
You've got a fund in me
(you've got a fund in me)

Bear, you're always losing here and there
Your own bonds aren’t wanted anywhere
If your lenders look behind
And don't like what they find
There's one thing you should know
You've got a fund you owe
(you've got a fund you owe)

I used to say "I" and "me"
Now it's "us,” now it's "we"
I used to say "gains are mine"
Now it's "Bear, loss is thine"

Bear, most lenders would just make me pay
I don't listen to a word they say
They don't see me as you do
They think they’re being screwed
I'm sure they wouldn’t care
If they had a friend like Bear
(a friend) Like Bear
(like Bear) Like Bear

by Anonymous on 6/23/2007 11:24:00 AM

We begin to get some backstory on the Great Bear Hedge Fund Meltdown of 2007, courtesy of the New York Times. The leitmotif, which I prophesy will become the Unshakable Story That Everyone Will Stick To, is that this is all directly and apparently unproblematically related to subprime mortgage loans:

The crisis this week from the near collapse of two hedge funds managed by Bear Stearns stems directly from the slumping housing market and the fallout from loose lending practices that showered money on people with weak, or subprime, credit, leaving many of them struggling to stay in their homes.

Let's leave, for the moment, the question of the incredibly complex and opaque layers of leverage, synthetic structures, derivatives swaps, and mark-to-model valuations that transformed mere commonplace mortgage loan write-downs into 23% losses of $600MM invested equity in approximately 9 months on a fund created because its precursor fund, which had dawdled along for two years or so generating a mere 1.0-1.5% a month return, we are informed, just wasn't good enough for the high rollers who didn't damn well put their money in hedge funds to earn 12-18% a year. This is really all about a bunch of subprime loans.

Notice deployment of the Mozilo Defense:

The first fund, the Bear Stearns High-Grade Structured Credit Fund — the one bailed out yesterday — was started in 2004 and had done well, posting 41 months of positive returns of about 1 percent to 1.5 percent a month. But investors were clamoring for even higher yields, which would require more aggressive bets on riskier mortgage-related securities and significantly higher levels of borrowed money, or leverage, to bolster returns.

So, a bunch of first-time homebuyers with no money made Angelo write a bunch of regrettable loans. Angelo undoubtedly made Bear Stearns buy those loans. A bunch of insane hedge fund investors who aren't happy with 12-18% annual returns from investing in the first loss position on the loans Angelo was forced to make got out their pitchforks and "clamored" until Bear Stearns gave them a new fund that used 10x leverage to sell protection to somebody who is exposed to the losses on the underlying reference securities (you want to bet me that'd be Fund 1?) that were valued by Bear's nifty models to start with.

No, wait. All that stuff is way too complicated for any reader of the Saturday Times to follow. Let's stick with how this "stems directly" from Teh Subprime. Besides the fact that we all know what Teh Subprime is about (don't we?), which makes this story easier to understand, it helps us get away from the implications of printing things like this:

Bear Stearns is bailing one of the funds out because it is worried about the damage to its reputation if it stuck investors and lenders with big losses, said Dick Bove, an analyst with Punk Ziegel & Company.

“If they walked away from it, investors would have lost all their money and lenders would have lost all of the money,” Mr. Bove said. But “if they did that to everyone in the financial community, the financial community would have shut them down.”

You see, unlike those deadbeat subprime homebuyers, Bear Stears is honorable enough not to stick it to the bagholders. Sure, that aborted attempt at the Everquest IPO might appear to have been an attempt to find a different subset of the "financial community" to stick it to, but Bear obviously realized that its holy reputation might not withstand offloading the nuclear waste onto retail investors, so it dutifully fell on its own sword and bailed out the people who forced it to open such a stupid fund in the first place.

But horrors! cries the crowd. What about BSC's shareholders? Why should they pay for this fiasco?

The Times doesn't mention that part, but if Fitch is to be believed, the "bailout" of Fund 1 is not an equity infusion but . . . wait for it . . . a loan modification! Apparently BSC is offering Fund 1 a collateralized repo facility with which the "financial community" can be paid off and BSC can now be collateralized by fund assets that still do or do not have any value as far as we don't know.

Unfortunately, the earlier storyline we spent most of last week on, the question of how much of all this to-do was a mere strategem to avoid having to mark to market any of this fine "collateral," now appears to have retreated a bit. I must say I'm wondering how Bear Stearns can can offer a collateralized repo facility to a "troubled" hedge fund and not mark that sucker to market every day of its life. Can anyone explain how this is going to get unwound?

No, we can't explain how this is going to get unwound. Let us, therefore, focus obsessively on lenders making bad mortgage loans to subprime borrowers. If we do that, maybe people won't notice that there don't seem to be nearly enough reported principal losses on actual subprime loans to account for the magnitude of the BS Funds' losses on a dollar-for-dollar basis, which does kind of suggest to us simpletons that something out there is magnifying, rather than dispersing, all this credit risk.

Remember the Brookstreet story? Catastrophic mark-to-market losses on a whole mess of mortgage-backed bonds that seem to affect only one brokerage? And nobody else seems to be marking to that price? Or could it be that everyone else is, in fact, marking to that price, but no one else was either stupid or criminally insane enough to buy illiquid and hence somewhat fuzzily-valued bonds for customer accounts at 9 to 1 leverage?

Nah, it's those stupid subprime borrowers.

by Calculated Risk on 6/22/2007 03:55:00 PM

From Standard & Poor's: 133 Subordinate Second-Lien, Subprime Ratings From 2006, 2005-Vintage RMBS On Watch Neg, Cut

Standard & Poor's Ratings Services today took various rating actions on 133 subordinate classes from 62 different transactions from 23 different issuers. We downgraded 45 classes backed by closed-end second-lien collateral. ... The downgrades and CreditWatch placements reflect early signs of poor performance of the collateral backing these transactions.

UPDATE: Here is the story from Reuters: Fitch, S&P may cut ratings on subprime debt

Standard & Poor's cut or may cut the ratings of 133 subprime-related securities, potentially affecting about $1 billion in securities, the rating company said.

It downgraded 56 classes of residential mortgage-backed securities in total -- 45 groups backed by closed-end, second lien collateral and another 11 subprime classes.

Most of the residential mortgage-backed securities originated in 2005 and 2006, and the percentage of delinquencies in that group has risen to as high as 18 percent, S&P said.

by Anonymous on 6/22/2007 03:33:00 PM

I kiddeth you not. "Fitch Places Bear Stearns' 'CAM2' CDO Asset Manager Rating on Watch Negative":

Fitch Ratings-New York-22 June 2007: Fitch has placed Bear Stearns Asset Management's (BSAM) 'CAM2' CDO Asset Manager Rating on Rating Watch Negative following recent reported adverse developments associated with BSAM's High Grade Structured Credit Strategies hedge funds, and the resultant uncertainties related to the on-going business strategy and capacity of the High Grade Structured Credit Strategies team.

Depending upon the resolution of recent developments with BSAM's High Grade Structured Credit Strategies hedge funds, BSAM's capacity to maintain its level of Structured Finance CDO collateral management may change. Fitch is continuing to monitor developments at BSAM and its hedge funds.

UPDATE:

22 Jun 2007 3:55 PM (EDT)

Fitch Ratings-New York-22 June 2007: The credit ratings of The Bear Stearns Companies Inc. (Bear Stearns) will not be affected by today's announcement to provide up to $3.2 billion in secured financing to The Bear Stearns High-Grade Structured Credit Fund (High-Grade Fund), according to Fitch Ratings.

The High-Grade Fund is a hedge fund managed by Bear Stearns Asset Management (BSAM). The Bear Stearns facility is a collateralized repurchase agreement, which can be readily funded with existing internal cash sources. The provision of repo financing is a product offered in Bear Stearns' usual commercial activity and does not constitute an equity investment. The Rating Outlook is Stable. A complete list of ratings is detailed at the end of this release.

The High-Grade Fund and The Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund (Enhanced Fund) have incurred redemption requests and margin calls which exerted severe pressure on fund liquidity following further deteriorating conditions in select subprime instruments. By replacing the current secured financing, Bear Stearns improves prospects to facilitate an orderly de-leveraging of the fund. Fitch views this action by Bear Stearns as a deliberate effort to optimize asset values and investor returns in this particular fund. However, Fitch does not believe this specific action sets a precedent for other funds managed by Bear Stearns. A case in point: BSAM will continue to work with creditors and counterparties of the Enhanced Fund to reduce leverage in an orderly manner and improve liquidity, but the company has not offered to provide any debt or equity. To proffer debt and/or equity across the BSAM fund universe could indeed have adverse rating implications.

by Calculated Risk on 6/22/2007 02:40:00 PM

Tanta posted on the Bear Stearns bailout this morning. Apparently this bailout is only for the less leveraged Bear Stearns Hedge fund: High-Grade Structured Credit Strategies Fund.

Assets are apparently being sold from the other fund - High Grade Structured Credit Strategies Enhanced Leverage Fund. CNBC is reporting that Cantor Fitzgerald has circulated a bid list for $400 million in debt securities from the Leverage Fund, and some bids are 10 cents on the dollar.

by Calculated Risk on 6/22/2007 02:13:00 PM

From Reuters: Fitch may cut CDO ratings linked to subprime loans

Fitch Ratings' derivatives unit on Friday said it may cut its ratings on some securities in debt products known as collateralized debt obligations because of exposure to deteriorating subprime loans.

The affected collateralized debt obligations, or CDOs, are: Trainer Wortham First Republic CBO III, ACA ABS 2003-1, ACA ABS 2003-2, and Ipswich Street CDO.
...
Securities from "three 2003 diversified (structured finance) CDOs and one high grade CDO issued last year may be downgraded," Fitch said in a statement.

by Calculated Risk on 6/22/2007 01:51:00 PM

From Bloomberg: Bank of America Report Sees Worse Mortgage Defaults

Losses in the U.S. mortgage market may be the "tip of the iceberg" as borrowers fail to keep up with rising payments on billions worth of adjustable-rate loans in coming months, Bank of America Corp. analysts said.
...
"The large volume of subprime ARMs scheduled to reset at higher rates in '07 and '08 will pressure already stretched borrowers," forcing more loans into foreclosure, the Bank of America analysts wrote from New York. A collapse of the Bear Stearns funds "could be the tipping point of a broader fallout from subprime mortgage credit deterioration," they said.

Didn't the CEO of BofA say the housing drag was about to stop?

by Anonymous on 6/22/2007 12:13:00 PM

The good news?

NEW YORK — Slumping sales and drooping prices haven't diminished homeowner optimism about their own nest egg's value, a recent survey shows.

The survey by Boston Consulting Group showed that 55% of Americans believed they could sell their house for more now than a year ago, down slightly from the 59% who felt that way last summer.

Nearly three-quarters think they could sell their homes within the next six months at a price they set, and 63% believe that real estate is a good or excellent investment.

The bad news?

However, most Americans aren't planning to buy a new home anytime soon. Only 27% said they were likely to purchase a house in the next five years.

UPDATE: The worst news? Tanta forgot to hat tip lama.