>> I realize that "all" the CDOs are considered toxic because the
>> bad mortgages are mixed with the good and it's impossible to
>> discern what's what.
>
> I think this is a bit of misinformation. CDOs are contracts just like
> anything else, and in order to be legally enforceable, they have to be
> clear on the details. What happened here was simple fraud:
Not really, no...
> Ratings agencies were tricked (willingly, I admit) into providing
> ratings for securities that represented the best parts of multi-part
> pools coupled with historical evidence of the issuer. If you take a
> pool and divide it into {risky-but-pays-higher-interest; medium
> risk, average interest; lower risk, lower interest}, each piece
> should be rated differently. Instead, the whole thing was presented
> to the ratings agencies as "From an A+ bank" and the whole thing got
> rated accordingly.
Not quite correct, actually. It is true that the average rating across
the tranches was often higher than it deserved to be, but the rating
situation is rather complicated, especially because it is possible for
a security to be extremely risky and yet AAA rated by virtue of the
odds of default being low. For example, a pool of Federally insured
mortgages has no default risk per se, but if the underlying mortgage
defaults there is a high prepayment risk which would cause you to lose
money. Such a security would still be AAA rated because the contract
was fulfilled without default, but a naive reader would not understand
the difference.
> There's lots ot be said about this, but let's just say
> that the ratings agencies got sloppy and greedy themselves; can you
> say "conflict of interest" ...? Now, if you're a money manager and
> you're offered three things, all rated the same, and one pays a better
> interest rate, which one do you pick?
>
> That's right: you pick the crap.
Again, not quite correct. Dealing with the horrid stub-ends of CMOs
was a specialist job, though frequently it appears that certain
organizations (including supposedly solvent European banks that I have
doubts about) would buy up instruments that were inappropriate for
them.
> Say you're gonna get 40bp more, you want all you can get!
The gap between the bottom and the top was typically more than 40
basis points.
> You're like Delorean in a drug deal. And if you're a $50k/yr "money
> manager" guy working for a pension fund in Iowa, your boss says: you
> can't buy anything you don't understand without buying insurance.
> So you price the insurance: top notch rating? That'll cost you 5bp
> (oops, should have cost you 200bp! Cue AIG, also not big on reading
> ...).
Actually, no. You couldn't buy credit-default swaps against
CMOs. CDSes insure against ORGANIZATIONAL default, not against a CMO
failing to pay off. They insure against, say, Goldman defaulting as a
company, not against a particular CMO issue having trouble.
>From reading so far, I'd suggest that the author of this probably
hasn't been directly enough involved with the industry to understand
the details, which is not surprising, but it does get a bit
irritating, the same way that hearing the guy on the radio railing
about how "taxpayers are borrowing to rescue AIG" (not true, that was
done by the Fed by printing money) gets a bit irritating.
> So what's happened here? Well, I'll tell ya: it's got not so much to
> do with "bad mortgages" or (as one of the candidates say)
> "irresponsible people who bought more house than they could afford"
> ...
Actually, it was the 2/28 loans and the people who thought they could
afford them that kind of sank the whole ship in 2007. Part of that was
idiots giving out loans people couldn't afford, part of it was people
stupidly taking out loans they clearly couldn't afford, and part of it
was people then trading those loans based on flawed credit models.
> What happened to Lehman and Bear (and to a certain extent Merrill and
> Goldman and Morgan) is they got extra greedy:
Er, no.
First, Bear was solvent when it blew up. They suffered from a bank
run, which appears to have been triggered -- it was murder, not
suicide, at the end, although they certainly had few friends as a
result of the LTCM debacle a few years earlier and as a result of the
fact that they'd been selling CMOs to their own captive hedge funds.
The text mentions Goldman, but didn't lose money on the whole mortgage
meltdown, because they were deeply short on the whole thing. They're
in great shape, and most of the shorting that happened last week was
incomprehensible. Morgan is also in pretty good shape.
Lehman, I don't know the details on yet. I will eventually.
Anyway, I'll again suggest that the author does not know the details
here, and the details matter *a lot*.
> if selling this crap is making money, I want to produce and sell
> even more. And in order to sell stuff, you have to buy stuff. But
> "stuff" in this case is pretty expensive, so you have to generate
> cash -- and get your nominal overlord regulator (surprise! Paulson
> is a former Goldman exec!) to give you the green light to lever it
> up to 30:1.
Er, they seem to have the facts off there, too.
Paulson became Treasury Secretary in 2006. Permission by the SEC for
the big five investment banks to exceed 12 to 1 leverage was in
2004. SEC isn't Treasury, by the way.
I'm going to be blunt. I wouldn't give much credence to to this guy's
writing. It isn't reasonable. I'd go through the rest in detail but
there is no point.
Perry
--
Perry E. Metzger [EMAIL PROTECTED]
