Sunday, March 18, 2007

Sub Prime .....Tick, Tick, Tick

I'm making it a point to educate myself in understanding the sub-prime mortgage ticking time bomb. My hypothesis is this: Sub-prime is a symptom of something much larger. It represents a vast ocean of money in search of yield. To meet the demand for yield, a preponderance of structured debt obligations were created. It represents the shifting of risks from the traditional holders to a broader base of holders who may be holding instruments in which all of the opportunity has been wrung out in terms of fees for all of the specialized handlers but none of the risk has been mitigated or perhaps even fairly reflected in the yield.

As I share this information with you, I will ascribe credit to the sources that I use, and as always, qualify my opinion on (as well as my ability to research) such matters as being woefully constrained by my general ignorance in how these sophisticated instruments work. What is becoming apparent to me, and I have no wish to disparage any party, is that this environment has been a very fee rich environment where the rewards are great and the risks (except to the ultimate purchasers of these obligations) are small. I'm willing to bet that the re-packaging of this risk and distributing it downstream eliminated the traditional safety valves that would have curtailed continued lending. In this fee rich/risk free environment, ordinary prudence was hit over the head and wrapped in a rug. Well, there are quite a few of these ordinary prudence corpses strewn about, and the air will begin to fill with the stench of them. I think we got our first whiff this past week. I'll also add...this stuff makes my head hurt.

Now, there are lots of people in the food chain of the structured debt obligations. My goal is not to provide an exhaustive detailing of that, but rather I'll provide you with links to resources along the way. My first recommendation is that you read Wikipedia's entry for collaterized debt obligations and mortgage backed securities. If you are balking at reading Wiki's entry, let me remind you that this knowledge is part of your continued erudition AND you will be the center of attention at your next cocktail party as you explain to others about the potential problems involved. Seriously folks, I believe that this will be as troublesome as the junk bond fiasco. So as a citizen, take 20 minutes to educate yourself. Yen carry trade--laugh at it. I don't think it is anything compared to the possible unwinding of these structured debt obligations. My greatest hope? That I'm wrong.

My first bit of research is to provide you with the following table. It is only slightly amended from the original table which you can find referenced within the table. While there are other types of asset back securities, I chose to limit the table to mortgage-related issues. This table shows the people who have insured the securities. in addition to sizing the total market for 2005 and 2006. As you can see (and presuming my understanding is correct) less than 5% of the total amount issued has been insured. You may also find it interesting to note that FGIC (Fidelity Guaranty Insurance Company is owned partially by Blackstone).

[click to make larger]


Gemma Star said...


This scares me.

Also, for those of us who think we're not at risk, I ask: Do you hold mutual funds? If so, what kind? Maybe you're at risk after all.

I plan to spend more time following up on your links later --BUT not late at night. I have enough trouble sleeping. This information is truly nightmare-inducing.

Gemma Star

PS: And, yes, my greatest hope is yours: That you're completely wrong -- and I'm not counting on that. You're a very shrewd, sharp lady.

Love your blog!

russell120 said...

Some of the "insurance" parts of the securitization market are done with derivatives. The credit default swap being a prime example, but also various interest rate swaps (variable for fixed, or vice versa).

The insurers of course can use these instruments to protect their positions. But who stands where in the current situation is probably not known in its entirety by anyone.

Anonymous said...

Do you review this site, some fees for complete reviews but much good information, opinions, and discussion is free?

His discussion of the Asian crisis in the late 1990's taught me a lot.

Your efforts to document and explain this sub-prime situation are well appreciated. Thanks.

Leisa said...

Gemma Star--thanks

Russell--yes, the credit derivatives are something else entirely.

Anonymous: Thanks. Yes, I visit Roubini's site from time to time. I think that he is one of the "good guys" that have been derided by those who want the party to last forever. Marc Faber and he think similarly (to my view anyway).

russell120 said...

"the credit derivatives are something else entirely".

Yes, but they also are a prime candidate for transmitting problems to other economic activities. They are also a prime suspect for a connection to the various (Yen, etc) carry trades. The person who buys the credit default (accepts the risk) is given a stream of income in return for their risk acceptance. This matches up well with the stream of (low) interest payments that they would owe on their Yen, Swiss Franc, etc. Though these two party products that are not very liquid, they do allow for a considerable amount of leverage. Presumably different positions are used to spread the risk of individual holdings, but when whole markets move, odd things can happen(LTCM anyone?).

The amount of (leveraged) money in the derivatives market is considerably larger then the amount of money in the actual subprime loans.

Leisa said...

Russell...Understood, and when I stated "it is something else entirely" it was acknowledging that it is another large ball of string to be unwound. With the increasing spreads in the bond market on corporate bonds, and some time this trading back and forth would seemings stop being even and leaving someone with from large exposures. I wish I understood it better!