Shortly after the “collapse” a friend of mine sat in on a meeting where an ex-Lehman banker was pitching his services. Someone asked him, “so what went wrong”…this is what he said:
"Once upon a time someone started making tins of sardines. Soon there was a huge demand for those tins from all over the world, people were buying them and selling them like crazy. Then someone opened one".
"Once upon a time someone started making tins of sardines. Soon there was a huge demand for those tins from all over the world, people were buying them and selling them like crazy. Then someone opened one".
This image comes off: http://www.marketoracle.co.uk/Article8943.html
FD: I love the analogy to selling tins of sardines, and the blogger's explaination is just as simple ... sort of ...
The problem which Hank Paulson didn't understand before he went out shopping for that stuff - (with $350 billion in his back pocket...and he came back with two banks and an insurance company (not the same thing mate)); and which Timothy Geithner appears to be getting his head around in slow motion on Primetime...
Is that there are two things you need to know when you go shopping for second-hand mortgaged backed securities:
What's in the tin?
Is what's in the tin worth more than the price that's being offered?
To figure that out you got to open the tins, every one.
Meanwhile:
At Davos Professor Nouriel Roubini announced that all the big banks in USA are insolvent “zombie banks”.
What's unsettling is that no one contradicted him; and he's not the only one with that notion ( Geithners Bank Bailout Plan Gibberish "Not Ready for Prime Time").
Presumably if "only" half of his estimated $3.6 trillion hit on the "shadow banks" will be taken by US banks, then the balance is lying in the vaults of European and notably UK banks, so they must be zombie banks too?
Perhaps he's right? He's been right before...
But until there is a law that mandates valuations of bank assets used to assess capital adequacy (and insolvency), that are not, as characterized by International Valuation Standards as "fundamentally flawed and bound to be misleading”...
...who knows?
OK the latest fudges to US GAAP and IFRS might help to dress up the funeral parlor, but if anyone believed those machinations why is there this pervading suspicion that there are still a lot of "assets" that are well...not assets, floating around ( Fair-Value and Mark to Market...The Most Expensive Scam in History?).
Perhaps that could explain why no one wants to sell them?
I suspect that right now many Toxic Assets on the balance sheets are either (a) marked to the market before it completely stalled (July/August 2008 - i.e. a sort of mark-to-market/book value hybrid, or laughably "marked to quote") or (b) selectively held completely at book value (what was paid in the first place), or (c) valued according to the same internal rocket-science models that let the problem happen in the first place (held to maturity).
In which case the moment anyone starts selling that stuff "at a reasonable price" (my words...Fire-Sale to you!), mark-to-market, and everyone will be insolvent.
Mmm...best to keep it all under wraps!!
Either there is some monkey business going on (it wouldn't be the first time), or it looks suspiciously like the banks themselves haven't got a clue if they are insolvent or not, and neither do the regulators.
If so, then with all due respect, if THEY don't know, then how the heck does Nouriel Roubini know?
Until someone actually starts to open the tins and do some proper valuations (call it due diligence if you like - same thing), no one is going to have a clue about what is really going on. And I don't care if Professor Roubini says he has X-Ray eyes. The only way you can see what's in the tins is to open them up.
Rule of Thumb:
I'm a pretty simple guy and it's long time since I worked on mortgaged backed securities, and anyway those were all CMBS. But from what I remember, and unless they changed the rules, the way it worked was like this.
1: The "story-teller" (me), came up with a projection of the net cash flow going out twenty years or so (ha...ha!!). That was all about "telling a story" that everyone believed, the trick was to put in a "carefully considered" downturn just after the critical period and then spin a yarn about how the thing would come back to a long-term trend.
2: Then we did a valuation of the collateral, pretty straightforward; basically a sales comparison (mark to market), which we dressed up by validating that from an income capitalization and a depreciated replacement cost.
3: Then we got numbers on the thresholds for Debt Service Coverage Ratio (DSCR) and the Loan to Value (LTV) from the rating agency, and worked out a repayment schedule to maximize the number of AAA you get out of the waterfall (that's the process whereby the AAA gets any money coming in first, then the BBB etc).
4: Then you dream up some standard deviations for your assumptions and run a Monte Carlo analysis to check the default probability.
5: Go through a number of iterations, write some impressive narrative that no one ever reads, bind it up and send it off to get rated. Meanwhile the lawyer writes a 400-page stream of consciousness to justify his fee, and bingo, you are set to go!!
I do remember two things. First it was a long process, so if anyone is going to take a damaged MBS and package it up again (properly) to something that makes sense, it will take time, you can't hurry those things and get them right.
The second thing is that I was basically on the "credit" or "risk" side of the fence (the bad guy with no "vision"), and from time to time the sales people and "relationship managers" would come round and try and get me to be a "little less conservative".
Boy they were good!
They were always so friendly and polite, they remembered the names of my wife, my children and my dog, never pulled rank, never made like they were putting me under pressure, I almost believed they were going to be my best friends for life.
But this is the thing. No one ever, ever tried to get me to change my line on the value that went into the LTV. All they were ever interested in was pumping up the net income stream.
That's because that the DSCR was always the thing that determined how much investment grade you could distill out of the pot (i.e. AAA), and that was where the real money was because there was a world shortage for that stuff. Which explains why eventually people started stuffing junk into those tins, the temptation was simply too high. The LTV was just academic; that was the "pound of flesh" that would never get called, and got forgotten in ANNEX 43.
Rule of Thumb for valuing a MBS worst case , all you really need to know is the LTV.
This is pretty rough and ready:
I compared valuations of AAA mortgaged-backed securities on the Markit ABX HE Index with the S&P Case Shiller Index , putting the house price Index at 100% at it's peak in August 2006. OK that's a mix of MBS's not all are RMBS, but it's a benchmark.
I also put in:
1: The point at which Professor Roubini says that the house price index will bottom (by end 2009 and 44% peak to trough worst case).
2: The point at which I say housing will bottom (40% peak to trough by end 2010: (http://www.marketoracle.co.uk/Article8126.html)). This assumes that 2009 nominal GDP growth is slightly negative but long term interest rates stay low (I'm not sure about that one though).
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