Here's Jim Cramer from last week with his thoughts on Bear Stears. OOPS http://www.liveleak.com/view?i=2b7_1205751955&p=1
Ouch... does that guy post his predictions on this site under the name "BrooksBall"? He should have just said this instead...
he was totally wrong about bear not being in trouble but i am pretty sure he was talking about the bank of bear stearns and not the common stock. in that respect he was correct.
On the subject of JP Morgan, wikileaks has gotten hold of an internal JPM document that is basically a how-to guide to circumventing insider-trader regulations. "Somebody's got some splainin' to do!"
i don't doubt that he had some, but I read an article that Cayne had something like a billion $ worh of BSC stock, apparently BSC executives and employees were huge proponents of holding on to the stock for as long as possible. Seems to me that the premiums on that much would have been prohbitively expensive given the seemingly remote nature of the risk...but what do I know.
When megarich people lose a lot of money (relatively), they sound so humble and... human. At Bear Stearns, Meet the New Boss By LANDON THOMAS Jr. and ERIC DASH Published: March 20, 2008 James Dimon tramped through the rain on Wednesday evening and strode into the headquarters of Bear Stearns, the embattled investment bank he hopes to buy for a mere $2 a share. More than 400 Bear executives — seething, fearful and to their dismay, far poorer than they were a week ago — were waiting for him. Only days after his controversial deal for the beleaguered investment bank stunned Wall Street, Mr. Dimon, the chairman and chief executive of JPMorgan Chase, made an appearance at Bear Stearns, hoping to win over executives who have vowed to fight his offer. Mr. Dimon left many of them as angry and resentful as he found them. “I don’t think Bear did anything to deserve this,” Mr. Dimon said. “Our hearts go out to you.” “No one on Wall Street could have anticipated this,” he continued. “I feel terrible sometimes when people think we took advantage. I don’t think we could possibly know what you all are feeling, but I hope that you give JPMorgan a chance.” Over the next 45 minutes, Mr. Dimon made it clear that he hoped to retain the best employees at Bear but also made it plain that many of Bear’s 14,000 employees will lose their jobs as a result of the deal, struck at the urging of the Federal Reserve and the Treasury Department. JPMorgan executives plan to cull one Bear employee after another, while keeping the best performers, as they move to integrate the two firms. A few of the executives whom Mr. Dimon faced on Wednesday, all of whom own Bear shares, pledged to fight the deal in hopes of luring a better offer from a rival bank, a prospect that for now seems distant. Even so, Joseph Lewis, the largest shareholder of Bear, said in a securities filing on Wednesday that he would take “whatever action” necessary to protect his stake, including seeking out another suitor. “In this room are people who have built this firm and lost a lot, our fortunes,” one Bear executive said to Mr. Dimon with anger in his voice. “What will you do to make us whole?” The packed room of senior managing directors applauded. Mr. Dimon responded gingerly. “You’re acting like it’s our fault, and it’s not. If you stay we will make you happy.” But the Bear employee was not satisfied. “I think it’s galling you come into our house and you call this a ‘merger,’ ” the Bear executive went on. This time, Mr. Dimon was silent. But Mr. Dimon, ruddy-faced and sharply dressed in a light blue tie and white shirt, told the executives that those of them who stay might receive at least 25 percent of the value of their recent Bear stock awards in the form of JPMorgan shares. Those who stay until the deal closes will receive a one-time cash payment. Mr. Dimon urged them not to blame Bear’s management, the government or JPMorgan for their circumstances. Mr. Alan D. Schwartz, Bear’s chief executive, looking pale, summed it up. “We here are a collective victim of violence,” he said, his voice cracking. “It’s natural to be angry, and you’re not sure who to be angry at. But we have to put it behind us.” But there was a grudging acceptance of their fate, and a number of Bear executives urged colleagues to accept Mr. Dimon’s offer. “I’ve been here for more than 20 years,” one said. “This deal cost me big time. But if there wasn’t a deal, we’d be toast.” Since the deal was reached Sunday night, JPMorgan executives have tried to characterize the situation at Bear as business as usual. It is, however, anything but. Inside Bear, it is already clear that the new bosses have arrived. On Wednesday, as Mr. Dimon made his way across the street under March skies as dreary as the mood inside Bear, a JPMorgan security guard stood watch at Bear’s entrance. JPMorgan executives have appropriated offices for private meetings and begun placing calls from the desks of Bear executives. JPMorgan bankers are already calling most of the shots on Bear’s trading floor. Some Bear executives remained in charge of the risks the traders were taking. Bear traders are shellshocked. “Never in my wildest dreams did I believe we would be sold for $2,” one employee said Wednesday. In the past few days there have been several instances when Bear employees have lashed out at the JPMorgan executives, creating awkward moments. The greeting on the Bloomberg e-mail screen of one reads: “BSC Credit Sales ...for a little while.” On Monday, JPMorgan held conference calls with executives in various areas of Bear Stearns. Then on Tuesday, Mr. Dimon kicked off a call with Bear’s brokers at 1 p.m., telling them that his grandfather and father were brokers and that he was confident that the merged firm would be a formidable force on Wall Street. “I have broker’s blood in my veins,” one Bear employee recalls Mr. Dimon saying, adding that many of the brokers seemed inspired by what they heard. For now, JPMorgan expects to manage client accounts from Bear’s private bank separate from its own, according to a person briefed on the situation. Bear customers should not encounter any changes, this person added, although that could change in a few months. JPMorgan is, however, looking to use the deal to expand its prime brokerage business, which caters to hedge funds, and its commodities trading operation. JPMorgan executives also met with their own employees. On Monday, Steven D. Black and William T. Winters, co-heads of investment banking, talked to JPMorgan’s top 200 bankers. Executives then addressed the rank and file in JPMorgan’s cafeteria. In the past, JPMorgan has often struggled to integrate companies it has acquired. But that changed with the arrival of Mr. Dimon, who joined the bank as part of its merger with Bank One in 2004. From the start, he focused on stitching together its disparate businesses and wringing out costs.
The insurance is usually cost-free, in that potential upside exposure and gains are forfeited in order to remove any downside risk. It's simply writing long expiration calls and buying long expiration puts, only it is all privately structured and tailored over-the-counter on a case-by-case basis by the bank desk itself (it would not be BSC in this case). That being said, you're right he may have protected all the stock or possibly only 20% of it for all we know...
Couple of clarifications: 1. I believe Bear was in healthy operating conditions before the collapse and I still do. Toss a figure around, $18 billion in cash alone. It more than covers all their positions. What it experienced was a typical run at the bank. They had enough assets but couldn't convert all into cash quick enough, hence the collapse. 2. Why is Bear more exposed than Citi? It's not because of Abu Dhabi. $7 billion investment from Abu Dhabi now looks like a drop in the bucket with the trouble at Citi, which probably will lay off another 2,000 people (it already was rumoured before to lay off 17,000, 4,000 actually happened). CITIC NEVER invested in Citi. They thought about it, then the Chinese equivalent of the Treasury Department blocked it. Good move. The problem with BSC is that not only is it small, it is exclusively an investment bank. Sub-primes count for a much larger portion of their income. Citi, on the other hand, can use its consumer/retail banking to provide funding for its broker/dealer operations in trouble, something Bear can't do. For the same reason, Bank of America, which has a much larger consumer banking business (and smaller investment banking business), is doing much better than Citi. But like I said, Bear wasn't gonna collapse on its own weight. 3. Why did the Fed let JP buy Bear for $2 a share? Simple. They can't let Bear collapse. BSC lost its ability to operate even without the collapse. Would you enter a multi-million dollar contract with a firm that is rumoured to be not there any more soon? The US Economy is highly hinged on the financial industry. Even without the gloom of recession, the Fed probably wouldn't let Bear collapse. They are not only underwriters and servicers, but the counter-party to many multi-million (or even billion+) dollar contracts, hedges, etc which are owned not only by investment banks, but also schools, municipal governments, retired funds, etc. A Bear collapse would send a huge ripple on the economy. So the Fed effectively forced the deal down BSC board's throat. They said either tank $2 a share or go bankrupt and risk losing everything. As to why JP could take advantage of the deal, I personally think somebody at the Fed likes JP (or somebody at JP got connections) and tipped them off. 4. Did the Fed buy Bear for JP? Yes they did. Bear had a total of about $33 billion in risky positions. The Fed gave JP a "loan" for $30 billion. Take away the Liabilities and what do you have? Assets = Equity. Bear's net worth is a lot more than $3 billion + 240 million. 4. What is JP buying? From my understanding, it's not the whole firm, just the back office clearing and part of the broker/dealer operations. So about 14,000 people will get laid off. 4. Why did Bear stock subsequently go up? Simple. My take is that Bear employees account for 25% of the outstanding stock of the company. If Bear gets sold, not only do they employees lose all their jobs, but also their stock value. Barrow Hanley Mewhinney & Strauss owns another 9.75% (?), Jimmy Cayne 4.94%, Legg Mason 4.84% and Joe Lewis 9.36%. Morgan Stanley probably would be happy to let the deal go through, but if you add up that figure, it's close to 54%. Joe Lewis already threatened to sue if the deal go through and will try to block the deal. If he and Barrow can rally the employees, things could get very dicey when shareholders vote to go through or block a deal. So the recent rally is due to debt holders (who's interest is the deal going through) buying shares as they can to ensure the deal goes through. The stock price will converge to $2/share in (I don't know) 6 month when it gets approved. Of course, couple of speculators are also in on the deal, for the short term.
I think you are right. I'm sure Jimmy Cayne lost some money, maybe even a lot of money. But I doubt he would not shield his fortune at least somewhat from volatility, at least with some kind of put. Hell, he probably even did it at his own former firm. On the other hand, what you described doesn't sound like insurance. It sounds more like a collar. One final note, obviously Cayne's poker playing pot smoking ways won't do, but I think Alan Schwarz actually did a good job. He just happens to be in the wrong place at the wrong time. In fact, two months ago, there was a Bloomberg article on how he is reluctant to become the CEO of Bear at such a lousy time, but had no choice. Because Cayne was away and Schwarz being the Chair, he was running the firm any ways.
MFW, that's the optimistic view, and I really hope your entire analysis is correct. The Bear Stearns purchase/bailout has been compared to the Japanese practice of larger banks swallowing up smaller zombie banks while the government foots the bill. Let's just hope you're right and that's not the case. The consensus is that the 30 billion debt the Fed socialized are pretty much insolvent and worthless should Bear collapse. The resulting ripple would affect those downstream of Bear (plus Bears creditors, whom the Fed now guarantees) and horizontally to other firms who are trying to digest these paper inflated securities while appearing A-OK. Some economists are saying this isn't a problem of liquidity but rather insolvency (aka trillions and trillions worth of bad mortgages with no way to pay them yet and are bundled up securitized (cut down) into trillions and trillions of more money large banks hold as collateral). ****, if you want a wild guess... just because Lehman gave us the thumbs up on a favorable quarterly earnings doesn't mean they have favorable quarterly earnings. A black box is a black box is a... Even if that's true, the market will willingly accept their word because the markets right now are spooked of meltdown. Everyone and their mothers and their mother's mothers are hoping epinephrine shots by the Fed are good enough to let the poison run its course.
At least at the moment, I don't think I am being optimistic. Rather, I think you are being pessimistic. Yes the situation is bad, but I think it has been over-sensationalized by the media that the general public do not know what to believe. Put simply, I don't believe the bad mortgages have reached "trillions and trillions" like you put it. Contrary to public opinion, the 30 billion risky positions Bear hold (the majority being MBS) actually have value. Without going into details regarding the whole business (something that would take longer than this post), only a fraction of that 30 billion is actually insolvent. The rest have devalued but only nominally. Bear securities credit scores have expectedly dropped so of course you expect their prices to drop. But has long as you don't sell them, you take no loss. In fact, you could hold them to maturity.
MBS has questionable value because no one has yet pinpointed where the extent of the damage lies. Instead of passively witnessing the effects of a Bear bankruptcy, Bernanke decided to prop up that market with 30 billion by declaring it Too Big To Fail. If you thought ratings agencies were taking a hit now, they would've been clobbered with a panic on the values of other MBS. As for holding the MBS to maturity, that would be sensible if major players weren't over leveraged by greed over its then-wild profitability. Holding it during a panicked sell off and amidst margin calls would, in the short term, prove disastrous in profitability.
The greed is proving to be systemic in nature... Derivatives the new 'ticking bomb' Buffett and Gross warn: $516 trillion bubble is a disaster waiting to happen By Paul B. Farrell, MarketWatch Last update: 7:31 p.m. EDT March 10, 2008 ARROYO GRANDE, Calif. (MarketWatch) -- "Charlie and I believe Berkshire should be a fortress of financial strength" wrote Warren Buffett. That was five years before the subprime-credit meltdown. "We try to be alert to any sort of mega-catastrophe risk, and that posture may make us unduly appreciative about the burgeoning quantities of long-term derivatives contracts and the massive amount of uncollateralized receivables that are growing alongside. In our view, however, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal." That warning was in Buffett's 2002 letter to Berkshire shareholders. He saw a future that many others chose to ignore. The Iraq war build-up was at a fever-pitch. The imagery of WMDs and a mushroom cloud fresh in his mind. Also fresh on Buffett's mind: His acquisition of General Re four years earlier, about the time the Long-Term Capital Management hedge fund almost killed the global monetary system. How? This is crucial: LTCM nearly killed the system with a relatively small $5 billion trading loss. Peanuts compared with the hundreds of billions of dollars of subprime-credit write-offs now making Wall Street's big shots look like amateurs. Buffett tried to sell off Gen Re's derivatives group. No buyers. Unwinding it was costly, but led to his warning that derivatives are a "financial weapon of mass destruction." That was 2002. Derivatives bubble explodes five times bigger in five years Wall Street didn't listen to Buffett. Derivatives grew into a massive bubble, from about $100 trillion to $516 trillion by 2007. The new derivatives bubble was fueled by five key economic and political trends: 1. Sarbanes-Oxley increased corporate disclosures and government oversight 2. Federal Reserve's cheap money policies created the subprime-housing boom 3. War budgets burdened the U.S. Treasury and future entitlements programs 4. Trade deficits with China and others destroyed the value of the U.S. dollar 5. Oil and commodity rich nations demanding equity payments rather than debt In short, despite Buffett's clear warnings, a massive new derivatives bubble is driving the domestic and global economies, a bubble that continues growing today parallel with the subprime-credit meltdown triggering a bear-recession. Data on the five-fold growth of derivatives to $516 trillion in five years comes from the most recent survey by the Bank of International Settlements, the world's clearinghouse for central banks in Basel, Switzerland. The BIS is like the cashier's window at a racetrack or casino, where you'd place a bet or cash in chips, except on a massive scale: BIS is where the U.S. settles trade imbalances with Saudi Arabia for all that oil we guzzle and gives China IOUs for the tainted drugs and lead-based toys we buy. To grasp how significant this five-fold bubble increase is, let's put that $516 trillion in the context of some other domestic and international monetary data: * U.S. annual gross domestic product is about $15 trillion * U.S. money supply is also about $15 trillion * Current proposed U.S. federal budget is $3 trillion * U.S. government's maximum legal debt is $9 trillion * U.S. mutual fund companies manage about $12 trillion * World's GDPs for all nations is approximately $50 trillion * Unfunded Social Security and Medicare benefits $50 trillion to $65 trillion * Total value of the world's real estate is estimated at about $75 trillion * Total value of world's stock and bond markets is more than $100 trillion * BIS valuation of world's derivatives back in 2002 was about $100 trillion * BIS 2007 valuation of the world's derivatives is now a whopping $516 trillion Moreover, the folks at BIS tell me their estimate of $516 trillion only includes "transactions in which a major private dealer (bank) is involved on at least one side of the transaction," but doesn't include private deals between two "non-reporting entities." They did, however, add that their reporting central banks estimate that the coverage of the survey is around 95% on average. Also, keep in mind that while the $516 trillion "notional" value (maximum in case of a meltdown) of the deals is a good measure of the market's size, the 2007 BIS study notes that the $11 trillion "gross market values provides a more accurate measure of the scale of financial risk transfer taking place in derivatives markets." Bubbles, domino effects and the 'bad 2%' However, while that may be true as far as the parties to an individual deal, there are broader risks to the world's economies. Remember back in 1998 when LTCM's little $5 billion loss nearly brought down the world's banking system. That "domino effect" is now repeating many times over, straining the world's monetary, economic and political system as the subprime housing mess metastasizes, taking the U.S. stock market and the world economy down with it. This cascading "domino effect" was brilliantly described in "The $300 Trillion Time Bomb: If Buffett can't figure out derivatives, can anybody?" published early last year in Portfolio magazine, a couple months before the subprime meltdown. Columnist Jesse Eisinger's $300 trillion figure came from an earlier study of the derivatives market as it was growing from $100 trillion to $516 trillion over five years. Eisinger concluded: "There's nothing intrinsically scary about derivatives, except when the bad 2% blow up." Unfortunately, that "bad 2%" did blow up a few months afterwards, even as Bernanke and Paulson were assuring America that the subprime mess was "contained." Bottom line: Little things leverage a heck of a big wallop. It only takes a little spark from a "bad 2% deal" to ignite this $516 trillion weapon of mass destruction. Think of this entire unregulated derivatives market like an unsecured, unpredictable nuclear bomb in a Pakistan stockpile. It's only a matter of time. World's newest and biggest 'black market' The fact is, derivatives have become the world's biggest "black market," exceeding the illicit traffic in stuff like arms, drugs, alcohol, gambling, cigarettes, stolen art and pirated movies. Why? Because like all black markets, derivatives are a perfect way of getting rich while avoiding taxes and government regulations. And in today's slowdown, plus a volatile global market, Wall Street knows derivatives remain a lucrative business. Recently Pimco's bond fund king Bill Gross said "What we are witnessing is essentially the breakdown of our modern-day banking system, a complex of leveraged lending so hard to understand that Federal Reserve Chairman Ben Bernanke required a face-to-face refresher course from hedge fund managers in mid-August." In short, not only Warren Buffett, but Bond King Bill Gross, our Fed Chairman Ben Bernanke, the Treasury Secretary Henry Paulson and the rest of America's leaders can't "figure out" the world's $516 trillion derivatives. Why? Gross says we are creating a new "shadow banking system." Derivatives are now not just risk management tools. As Gross and others see it, the real problem is that derivatives are now a new way of creating money outside the normal central bank liquidity rules. How? Because they're private contracts between two companies or institutions. BIS is primarily a records-keeper, a toothless tiger that merely collects data giving a legitimacy and false sense of security to this chaotic "shadow banking system" that has become the world's biggest "black market." That's crucial, folks. Why? Because central banks require reserves like stock brokers require margins, something backing up the transaction. Derivatives don't. They're not "real money." They're paper promises closer to "Monopoly" money than real U.S. dollars. And it takes place outside normal business channels, out there in the "free market." That's the wonderful world of derivatives, and it's creating a massive bubble that could soon implode. Comments? Yes, we want to hear your thoughts. Tell us what you think about derivatives: as "financial weapons of mass destruction;" as a "shadow banking system;" as a "black market;" as the next big bubble dangerously exposing us to that unpredictable "bad 2%."
In that case let me give a brief overview of MBS deals. It's gonna be a long post, but I've already taken out a lot of fine details. Let me also assume that it is an one group deal (instead of two+) A typical sub-prime MBS deal averages around $500 million nominally. There are those as little as $200 million, with the big ones easily going $1.5 billion+. It's not the whole deal that is a single bond, but rather, a collection of several bonds. The "first" one is typically called the A-1 class or tranche. Then A-2, A-3... Following them are the "mezzanine" certificates, M-1 up to M-12, maybe higher. Then you might have the subordinates, B-1 up to B-6 and a couple of servicing tranches such as R-1, R-2, P, X, etc. More on those later. I've noticed some posters say that "if you package crap in a security, it is still crap." Well, that's not really true. When you have just one bond, if it fails, you lose everything. It is make or break. When you package them together, not all of them will fail (indeed, not even close to all sub-primes have failed right now) so you still have some value left in your bond. Also, they take mortgages from all over the country, so if foreclosure is high in NOLA after Katrina, the bonds in say, New York, is still paying. To further protect the deal, most MBS are overcollateralized. So remember that $500 million deal? It may be backed up $750 to $800 million worth of sub-prime mortgage, giving additional protection. This means that not only do you have excess principal protection, but you also have additional protection from the excess interest generated by those overcollateralized mortgages which are not paid on the bonds. Interest on the mortgage is typically higher than interest on the bonds. Let's say the weighted average coupon (interest) on the mortgages is 7%, typically 0.5% goes to the underwriter, maybe another 0.04% to the trustee, then you may have bond insurance, collectively not more than 0.75%. So the bond interest would only be maybe 6.25% This overcollateralization percentage (% of the bond, not amount) also has to be maintained for the most part. Let's say the OC target percentage is 3.5% of the deal, if it drops below that percentage, excess interest is used to pay off all bonds until that percentage is reached again, or until excess interest runs out, in which you have a loss. But even in that case you don't lose everything. Remember, all of those bonds are backed by houses/retail property, there is some recovery value, which go to the A classes first (see next paragraph for why). Another protection is the use of subordination. If excess interest is unable to cover the OC and you have a loss, the first hit are the B classes, then the M's, then the A's (that's why it's called the senior certificates/tranches). It is for this reason the A classes are typically rated AAA to A, the M-1 to M-9 BBB to B, then M-10 onwards and B's aren't even rated because nobody in their right mind would buy them, so why waste the money doing so. The underwriter typically hold on to those themselves. I remember S&P and Moody's got shelled for rating the A certificates AAA's when the whole sub-prime mess started. Of course they're rated AAA's, they are say, $150 million in bonds backed by $250 million OC and another $400 million in subs. Effectively that's $150 million backed by a total of $800 million in mortgage. If you have access to a Bloomberg terminal and could open an MBS deal, you'd see that maybe the M-7 class is trading at 70 cents on the dollar, but an A, even A-8 is still trading at around 92/93. So Moody's and S&P were right rating them AAA's because they actually are very safe. It is more hedge funds/retirement funds that don't know what's going on, or knows what's going on and want to shift the blame playing the game. In fact, sovereign funds, which buy nothing other than AAA's are very safe in their investment, especially considering how they typically hold them to maturity. So how does how this affect Bear? If BSC holds onto all the crap they underwrite (late M's and B's), wouldn't they be insolvent? Well, Bear not only underwrites, but is also a broker/dealer. They also buy A and early M certificates, which is actually a significant amount of that $33 billion. Besides, if you really want Bear troubles to not ripple through the economy, you'd hope all of that $33 billion are junk they can't sell. Because they underwrote those deals and there is no counterparty, in which case the $30 billion the Fed gave JP could more than bail them out. Normally they wouldn't have needed those bail outs. Before the troubles started, a typical month averages 80 - 90 MBS deals (that the whole market, not just Bear). Even if those hold onto those risky positions, the new deals Bear underwrites could more than cover any losses those late M's and B's generate (whatever they get back is bonus, which they typically receive some). The problem is, since the sub-primes started, the number of deals have fallen to under 20 (I think 12 last month). Bear simply couldn't generate enough cash flow to cover a run at the bank and they never could sell those late M's and B's for additional cash. So yes, that $33 billion have value, not to that amount, but enough that they can be bailed out. It was a great deal for JP. Bear was a $1.5 billion (profit, not revenue) a year company before the sub-primes. They'll go back to being a $1 billion a year company after the sub-primes. JP just picked it up for nothing. Furthermore, sub-prime MBS collectively may total trillions and trillions, but losses in them do not (like in your post). Some of the value can be recovered. Take Citi for example, which posted $18 billion in write downs. Following Enron and WorldCom, the morons in Congress fell in love with the ideal of fair value. "We should value companies at fair value, not nonsensical accounting values" they said. So in their infinite wisdom, they forced the SEC and FASB to recognize all securities at "market value," the price they are traded on the market at balance sheet date. Prior to that, you only adjust the value of investment securities when there is evidence of impairment (e.g. realized loss when you actually sell the securities, or when the payment on the investments actually do stop). Following the accounting rule of "conservatism," you never adjust the value upwards. Now however, they want companies to adjust both upwards and downwards under "unrealized gains and losses," increasing volatility and adding almost no valuable information. Citi's losses would fall into this category, new book losses but not realized losses. I'm sure some of them would eventually fail, but not to the extent of $18 billion.
One more thing. The most significant downside risk to an MBS deal other than losses would perhaps be prepayment. That is their most significant difference from cookie-cutter corporate bonds. You have Joe Bob, who owns a house. He may one day say, wait a second, why am I paying 7% on a mortgage when I have some extra cash lying around that I'm not investing? I'm gonna pay the mortgage off. So here you are, investment banker who bought the bond backing that mortgage (along with several others) paying 6.25%. You are expecting to be paid 6.25% for the next 30 years. Now all of a sudden the mortgage (and hence your bond) is paid off and the Feds have already lowered rates. So you can't find another similarly risk leveled security paying 6.25%, reinvestment risk at its finest. It is for this reason that investment banks spend significant resources building models to try to predict different results under different prepayment scenarios. Underwriters do provide prepayment assumptions (loss and other modeling assumptions as well) in the prospectus, but those are typically wrong as soon as the first period is over, because they simply can't predict the future losses and prepayments. Now however, Joe Bob might say, the economy is going down the toilet (says the media). I'll hold on to my money. So for firms holding investments to maturity (hint hint, sovereign funds, etc), yield and risk may actually go down.
JPM getting BSC for $2 is robbery. They take no risk (Govt) and get all the reward. Their stock (JPM) has gone up 20%. If I was shareholder I would sue.
Thanks for the writeup MFW. I've been interested in finance but I admit that I have basic idea of CDOs. I read that one of the problems from the subprime mess is that the most volatile and risky tranches were given AAA ratings which sparked the host of problems we're seeing now. Plus there were estimates that around 20% of these MBS consisted of subprime loans. I'll have to organize my thoughts on this, but some initial questions came up from your post: Do you see it to be a great conflict of interest for banks like Bear Stearns be an underwriter while being a broker/dealer...should Glass-Steagal be revised and reenacted? And I thought the Fed bailout was based upon the assumption of protecting/firewalling Bear Stearns' counterparties and the ensuing domino it would cause had BS imploded?
The whole mark to market requirement was one of the worst aspects of the knee-jerk reaction to the Enron failure. While well thought out regulation is never a bad thing, doing something in a knee jerk reaction usually only makes things worse. At the end of the day, these large write-offs will be more about paper losses than true economic losses. People forget these loans are still backed by buildings - which even if down 20%-30%, still have value. As a result, when these banks are writing down loans to pennies on the dollar (b/c they can't find a buyer, so they keep dropping its assumed value), they're to an extent being forced to overstate the loss.
