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.

by Anonymous on 6/22/2007 08:10:00 AM

I predict that us UberNerds are going to spend a lot of time getting irritated in the coming weeks.

The OC Register reports on the Brookstreet mess:

In another fallout from Orange County's subprime mortgage industry collapse, Brookstreet Securities Corp., an Irvine broker dealer, shut its doors and laid off 100 local employees because it could not meet margin calls on complex securities backed by faltering mortgages, company spokeswoman Julie Mains said.

Mains said Brookstreet went from $16 million in capital Friday to being $3 million under water Wednesday because its clearing firm, National Financial Services, demanded payment for securities bought on margin.

The securities, known as collateralized mortgage obligations, lost value as Wall Street confidence in mortgage-backed securities collapsed. The most prominent collapse was this week's demise of two Bear Stearns & Co. hedge funds worth $20 billion that invested in collateralized mortgage obligations, which are mortgage-backed securities with varying maturity dates, risk and yields.

Mains said the value of Brookstreet's securities plunged to 18 cents on the dollar, forcing the company to dip into its capital to meet margin calls, which is when investors must increase deposits to meet minimum account requirements.

"It wasn't a problem with securities," she said. "It was a problem with the margins." . . .

The National Association of Securities Dealers ordered Brookstreet to liquidate its remaining accounts Wednesday, Mains said. Some customers lost the entire value of their investments while others "did indeed go negative," Mains said. She said clients should try to find another broker-dealer to take over their accounts.

Mains said clients should have known they were making risky investments, but consumer attorneys said CMOs should only be sold to pros.

Stuart Meissner, a New York attorney and former securities regulator, said he received calls from people whose Brookstreet accounts went from $250,000 to negative value. "They were supposedly guaranteed 10 percent returns," Meissner said.

Sam Edwards, a Houston attorney who has sued Brookstreet for investment malpractice, said he received calls from clients across the country complaining about losses in collateralized mortgage obligations bought on margin.

"These are very complicated, very high-risk securities and not appropriate for retail customers," Edwards said.

Dear OC Register: if we are going to make comparisons to Bear Stearn's hedge funds, and we are going to make statements to the effect that the securities in question are too complex for retail investors, it might possibly help matters if you would verify that we are really talking about Collateralized Mortgage Obligations as opposed to Collateralized Debt Obligations.

I suggest, reporters, that you call a specialist--Mark Adelson at Nomura appears willing to talk to the press, as does Janet Takavoli--and ask for a brief education in the difference between these two types of structured finance. If in fact Brookstreet was selling CDO tranches to retail investors, that's a big deal. If they were CMOs (also known as REMICs)? Well . . . the bond market is certainly going to change pretty radically if we declare that REMICs--as such--are too toxic for retail investors.

by Anonymous on 6/22/2007 07:09:00 AM

From the indefatigable Bloomberg, "Bear Stearns Plans $3.2 Billion Fund Rescue to Halt Fire Sale":

June 22 (Bloomberg) -- Bear Stearns Cos. plans to take on $3.2 billion of loans to stop creditors from seizing assets of one of its money-losing hedge funds in the biggest fund bailout since 1998, people with knowledge of the proposal said.

The firm told lenders to the High-Grade Structured Credit Strategies Fund yesterday that it would assume their loans, said the people, who declined to be named because the plan is confidential. The New York-based firm stepped in after Merrill Lynch & Co. took securities that backed $850 million in credit lines to two Bear Stearns funds and put them up for sale. JPMorgan Chase & Co. and Lehman Brothers Holdings Inc. also indicated they may take over collateral for loans they provided.

``Bear needs to put this behind it as soon as possible,'' said Peter Goldman, who helps manage $600 million at Chicago Asset Management, including shares of Bear Stearns. ``The firm might take on some of the risk of the fund they didn't have before, but they're a bond shop and they wouldn't take on risk they shouldn't.''

How true. Who ever heard of a bond shop taking on risk they shouldn't? What a Kidder!

This calls for a reprise of yesterday's celebration of mixed and mangled metaphors. I say we go back to an earlier classic moment in the history of bond shops that wouldn't take on risk they shouldn't:

"We never would have touched Kidder Peabody with a 10-foot pole if we knew there was a skunk in the place," Welch said to Kidder employees in a speech in early 1988, as reported in Fortune magazine, shortly after the scandal broke. "Unfortunately we did, and now we've got to live with it. But we're as committed to winning as we were on day one. We'd love you to win -- more than any mother in the world."

by Calculated Risk on 6/21/2007 06:04:00 PM

From Barron's: Bear Stearns Hedge Fund Woes Stir Worry In CDO Market (hat tip Chance)

... the value of CDOs is measured by a "marked to market" technique that pegs them to their value in the market, rather than their book value. ... CDOs containing mortgage-backed securities seldom trade, which can mean that their "marked to market" value does not reflect recent events.
...
[Peter Schiff, president of Euro Pacific Capital] argued that if the bonds in the Bear Stearns Companies Inc. (BSC) funds were auctioned on the open market, much weaker values would be plainly revealed.

"This would force other hedge funds to similarly mark down the value of their holdings. Is it any wonder that Wall street is pulling out the stops to avoid such a catastrophe?," Schiff said.
...
"Their true weakness will finally reveal the abyss into which the housing market is about to plummet," he said.

I'm not sure about housing "plummeting into an abyss", but I do think housing is poised for another downturn with no bottom in sight.

by Calculated Risk on 6/21/2007 05:50:00 PM

UPDATE2: Mathew Padilla has more: Brookstreet closes down, 100 laid off

From Reuters: Brookstreet Securities says may liquidate (hat tip Padilla)

Brookstreet Securities Corp. on Thursday said it "may be forced to close" after heavy markdowns in collateralized mortgage obligations, according to a letter the firm sent to investors this week.

"Disaster, the firm may be forced to close," Brookstreet told its investors in an e-mail dated June 20 that was obtained by Reuters.

Julie Mains, chief compliance officer, confirmed the contents of the e-mail.

UPDATE: From Investment News (hat tip Steve): B-D warns reps of 'disaster'

[From] in an unsigned e-mail note to its advisers ...

"Today, the pricing system used by National Financial has reduced values in all Collateralized Mortgage Obligation," the e-mail said.

"Many of those accounts were on margin and suffered horrendous markdowns and unrealized as well as realized losses.

National Financial and the regulators expect Brookstreet to pay for realized liquidated losses and take a capital charge for unrealized (mark) to market losses."

by Anonymous on 6/21/2007 01:17:00 PM

From Bloomberg, "Corporate Debt Risk Jumps on Concern Over Bear Stearns Funds":

June 21 (Bloomberg) -- The perceived risk of owning corporate debt rose worldwide on concern that the paralysis of two hedge funds run by Bear Stearns Cos. may cause a chain reaction that sparks losses for other hedge funds and the banks that finance them.

Credit-default swaps based on $10 million of debt in the CDX North America Crossover Index of 35 companies surged as much as $10,000 to a nine-month high of $179,000, according to Deutsche Bank AG. In Europe, the benchmark iTraxx Crossover Index of 50 European companies jumped as much as 16,000 euros ($21,400) to 216,000 euros, the biggest one-day rise in three months, according to Deutsche Bank.

Investors worry that the funds' problems are ``going to bleed through to other funds or dealers that are invested in other asset classes, which could result in further liquidations and forced-selling'' of assets beyond mortgage securities, said Matthew Mish, a credit strategist at Barclays Capital in New York.

So . . . all this "covenant-lite" paper was "perceived" to have your basic garden-variety normal risk until some BS hedge fund went to the edge over subprime-backed CDOs, and then all of a sudden it looked a touch wanton? Why, next thing you know someone will tell me it's cheaper to go naked long than to hedge this stuff . . .

by Anonymous on 6/21/2007 07:40:00 AM

It was a dark and stormy night; the rain fell in torrents--

The high-stakes game of brinksmanship began early yesterday on Wall Street, and continued throughout the day. Bankers traded telephone calls, frenetically negotiating the fate of two hedge funds.

All wanted to avoid a fire sale in the troubled mortgage-securities market, but at the same time, not get stuck with an exploding liability that could result in steep losses. The day ended with deals that appeared to have forestalled a meltdown. But questions remained about how successful they were and whether they had merely delayed the inevitable.

except at occasional intervals, when it was checked by a violent gust of wind which swept up the streets

June 21 (Bloomberg) -- Merrill Lynch & Co.'s threat to sell $800 million of mortgage securities seized from Bear Stearns Cos. hedge funds is sending shudders across Wall Street. . . .

``More than a Bear Stearns issue, it's an industry issue,'' said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. Hintz was chief financial officer of Lehman Brothers Holdings Inc., the largest mortgage underwriter, for three years before becoming an analyst in 2001. ``How many other hedge funds are holding similar, illiquid, esoteric securities? What are their true prices? What will happen if more blow up?''

(for it is in London that our scene lies),

One mortgage investor said that while the CDO assets for sale carried high credit ratings, they were backed by such risky mortgages as to be “junk in investment-grade clothing”.

rattling along the housetops, and fiercely agitating the scanty flame of the lamps that struggled against the darkness.

The bottom line is that big losses in subprime investments are likely to make investors more reluctant to risk their money on these instruments in the future.

That will make it harder for mortgage originators like banks to sell these types of loans in bundles to the bond markets, which will, in turn, reduce the availability of funds for subprime loans and make it much harder for subprime borrowers to obtain financing.

Nobody ever apologizes to Edward George Bulwer-Lytton. So I'm a contrarian. Herewith: apologies to Bulwer-Lytton.

UPDATE: Thank you, Outsider, for the perfect denoument to our overwrought little narrative:

"We're looking at somewhat immature markets that are going through a growth phase," Ralph Cioffi, senior managing director of Bear Stearns Asset Management, said at a bond conference in New York in February, Reuters reports. "There is a catharsis and a cleaning-out process."

Investors: If you can't tell who is having the catharsis, you're the catharsis.

FURTHER UPDATE: Every caprice needs a rondo.

But Hugh Moore, partner of Guerite Advisors and a former executive at a subprime mortgage lending company, described the situation as a "slow train wreck."

"I wouldn't be at all surprised if we hear about more [hedge funds] blowing up in the coming months, as the subprime market meltdown continues," he said. "You've got $250 billion of subprime [adjustable-rate mortgages] that are going to reset this year. I don't think it's going to be systematic . . . but for those people who invested in those hedge funds, its certainly not going to be fun."

So what's it going to be for those subprime borrowers? Just another day at the circus?

EVEN FURTHER UPDATE: Because connoisseurs will not want to miss this one, courtesy of mp:

Two American so called hedge funds, with combined values a couple of weeks ago of north of 20 billion dollars, are teetering on the edge of collapse. Who's the culprit? Sub-prime loans, mortgages to people who really couldn't afford one, backed by houses whose price is deflating like a balloon in a shooting gallery. Enter the vultures.

"A balloon in a shooting gallery"? Vultures . . . eat bits of popped balloon? This image isn't working for me . . .

by Calculated Risk on 6/20/2007 11:52:00 PM

From the WSJ: Bears Woes Test Markets' Mettle

... word spread that several investment banks were having trouble finding buyers for subprime mortgage securities they pulled out of the teetering hedge funds at the Wall Street firm.
...
J.P. Morgan Chase & Co. ... was scheduled to begin an afternoon auction of collateral it held from the bear fund ... Minutes before the sales were to begin, the firm pulled back. Later, J.P. Morgan came to terms with Bear to eliminate its exposure to Bear's troubled hedge funds .... Some traders said the bank might have been forced to settle with Bear because the loans it had put up for sale would have fetched so little in the market.

Deutsche Bank AG and Merrill Lynch & Co., among others, remained in limbo ... Earlier in the day Deutsche quietly approached some market participants to gauge their interest in some of its collateral assets ...

Merrill also planned to sell collateral and stopped negotiating with Bear ... some of the early prices bandied about for Merrill's assets were relatively low. But when Merrill's auction took place late in the afternoon, it managed to sell some higher-quality assets at reasonably high prices ...

What a mess. No one knows what many of these securities are worth; some of them may be worthless.

The biggest risk is that this is just the "tip of the iceberg" and that other hedge funds are about to go under. Another risk, mentioned in the WSJ article, is that "$250 billion in junk bonds and corporate loans are slated to be sold to investors" over the next four to eight weeks as part of the recent LBO wave. If investors become skittish - and that Fitch Ratings notice I posted earlier today might scare a few of them too - those debt sales might be in trouble.

Even if this is just a bump in the road, at the least this probably means another round of credit tightening for the mortgage market, and more downward pressure on housing.

by Anonymous on 6/20/2007 06:10:00 PM

Via Bloomberg, some excellent news from BOA:

June 20 (Bloomberg) -- The worst U.S. housing slump in 16 years will begin to ease in the next month or two, and job growth will lift home prices and spur construction early next year, Bank of America Corp. Chief Executive Officer Kenneth Lewis said.

``The drag stops in the next few months,'' Lewis said in an interview yesterday in New York. ``It's just about to be over. We're seeing the worst of it.'' . . .

``We do not see a recession,'' Lewis said. ``Because that drag stops, you'll see the economy begin to pick up in the third and fourth quarters.'

So much for those socialist girls at PIMCO with their "blood bath" nonsense.

(Thanks, JS!)

by Calculated Risk on 6/20/2007 04:37:00 PM

From Fitch Ratings: U.S. Leveraged Loan Covenant Decline Accelerating in 2007

The balance of power in the U.S. leveraged loan market continued to shift from creditor to borrower as protective covenant packages declined further during the first five months of 2007. The deterioration occurred amid vibrant and aggressive overall leveraged loan issuance.

• The percentage of leveraged loans containing a coverage covenant of any type dropped to 44.3% from 68.1% in 2006 and below the 1996–2006 average of 78.1%.

• The percentage of loans containing leverage covenants of any type fell to 51.1%, down from 69.6% in 2006 and below the 1996–2006 average of 72.8%.

• Along with the general demise of covenant packages has been the growth of specific “covenant-lite” loan issuance. In 2007 through May, $47 billion of “covenant-lite” transactions—those typically containing no financial covenants at all—have come to market; more than twice the level of covenant-lite issuance in all of 2006.

Overall lending is still "aggressive". And Fitch is worried:

In nearly any environment, such a radical deterioration in creditor protection would be cause for concern. Exacerbating the current trend, however, is that it is occurring amid an evermore aggressive rating mix of deals coming to market.
...
The near absence of corporate defaults appears to be a major factor behind the decline of key structural protections in the leveraged loan market. ... this lack of defaults is helping to create a self perpetuating and troubling pattern, whereby the low default rate enables deep speculative grade borrowers to get easy access to the loan and bond markets, and at increasingly favorable terms, as shown by the covenant trends discussed above. The result: nearterm defaults are avoided, which fosters some level of complacency and higher risk tolerance, ultimately allowing new issuance to take on even more aggressive characteristics. However, should economic growth soften more than anticipated or some other shock hit the market, the growing share of low quality loans and bonds ... will come under significant pressure. In other words, while defaults remain very low, risk in fact continues to move in the opposite direction.

by Calculated Risk on 6/20/2007 04:29:00 PM

From Dow Jones: Results From Sale Of Bear Assets May Not Be Clear On Wed (hat tip Brian)

While the deadline for a sale of Bear Stearns' ... hedge funds assets is not far, the results from the sale may not be clear until much later.

... Merrill Lynch & Co. (MER), which is circulating its list of $850 million of mostly highly-rated complex securities, may not be met...

That's because the securities - mostly collateralized debt obligations - on the auction block are extremely complicated, and it will take investors some time to assign what they believe is a fair value to these assets.

"At least a third of what is being shown is pretty esoteric stuff," said [Mark Adelson, managing director of fixed income research at Nomura Securities.] The bulk of collateral appearing on the bid lists are CDOs that are backed by a pool of mortgage bonds, and CDO squareds, which are CDOs of CDOs, similar in concept to a fund of funds, market participants said.