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 Tanta 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 Tanta 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 Tanta 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 Tanta 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 Tanta 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.