US house prices in freefall -- redux

[Ben Kenobi]

Joy, the wonder twin is here.

Which one are you rah?

http://uk.youtube.com/watch?v=Q3hJJNW1yuM

[rah]

I don't know. Actually....... I've never gone to youtube. But feel free to continue your education. You obviously need help with quite a few of the basics.

[Ben Kenobi]

Rah, just curious here.

When was the last post of mine that was serious?

[rah]

You only claim they're not serioius when proven wrong.

[Ben Kenobi]

Do you believe all my posts here were without any *hint* of sarcasm and were completely earnest?

[rah]

I could change your title to "Please don't pay attention to any of my post because I'm just pretending to be an idiot."

[Ben Kenobi]

That would greatly enhance your standing here I'm sure.

Isn't the official title "Village Idiot"?

[rah]

Naw, your logic and debating skills may suck, but I think you're still smarter than the village idiot.

[Ben Kenobi]

I'm pleased you hold me to such high standards.

I'm actually amazed that I can hold my own against such intellectual giants here on poly, like Imran who have an actual lawyer degree.

Seriously, you should commend him for his excellent performance here in this thread as a shining example for all that Apolyton should strive towards. If everybody were just like him this place would be much better.

Thanks for helping me see the light rah.

[Imran Siddiqui]

If everybody were just like him this place would be much better.

[rah]

Your welcome.

Then I guess my job here is complete.

Carry on.

let me know when you want me to make that change

[Ben Kenobi]

I'll make that my top priority.

I'm sure the change would bring joy to Apolyton.

[Japher]

Someone said "village idiot" and Lord Shiva still hasn't shown up?

[rah]

Time zone differences.

[PLATO]

Originally posted by DanS


I think the market is telling us at high decibels that those models aren't worth a bucket of warm spit.

Why don't you tell us why we should follow mark-to-myth, when most monetary worth is determined by the market in our economy? The worth of everything from oil to real estate, stocks to derivatives, is determined by the markets.

Indeed. The market is speaking volumes about the models. However, the problem wasn't the model. When you plug in $200 million of AAA debt into the model, it gives you the expected return. Historically, it has been fairly accurate. HOWEVER, here is the problem...The rating services were winking and nodding in cahoots with the investment banks and assigning AAA ratings to bb- debt due to appreciation covering the risk.

In short, if the models are fed accurate information, then they will supply accurate results.

Further, it is pure common sense to realize that even totally non performing real assets have a liquidation value that is a sizable percentage of the initial investment.

*****
Let's look at a $100 million dollar fund with a 7% "on paper" return. (In reality, many of the MBS's that are being firesaled have a higher expected return).

-Lets's assume an actual foreclosure rate of 20% (Which is WAY higher than reality)

This fund will return income on the 80% performing of $5,600,000
(This of course does not take into account paid down principle, but let's keep the math simple).

The 20% that was forclosed on will return no less than 60% of the original investment upon liquidation (In almost every case lenders are getting in the range of 70-75% on average, but we are looking at a worse case, right?). That will provide a liquidation value to the fund of $20 million X 60% or $12 million dollars.

The $80 million of fully performing assets plus the $12 million in liquidated assets gives you a fund value of $92 million dollars with a return of 5.6% based on the original value. The difference between the expected return and the actual return for the year is $1.4 million dollars or 1.4%.

Discounting the fund by that additional loss in expected return to $90.6 million dollars gives you the market value of this fund, which is over 90%.

Now, the market says a fund of this type is only worth $83 million dollars (or 83 cents on the original dollar). This is based on the irrational fear that the currently performing parts of the fund will foreclose (not default, but actually foreclose) at a rate much higher than the 20% used in this example!

Now, here is the kicker. The actual forclosure rate (Not the "foreclosure proceedings started", but the actual "sale on the courthouse steps" foreclosure) is less than 1%.

"Mark to myth"? The myth is the hysteria that is rampant in the MBS secondary market.

*******

Now, you ask, why would there be such an irrational fear? the answer is simple for anyone who has ever been involved in serious investing. In a word, it is "Uncertainty".

Investors are unwilling to invest in instruments that they have no idea where they may perform. Is your yield going to 7% or is it going to be 4%? Not knowing this answer makes this investment a pariah for most types of investors. This lack of demand, coupled with the vast volume of MBS's that exist drive the price down well below the actual value. In short, you have only speculators investing in a HUGE dollar volume of instruments.

All this, combined with the "mark to market" requirements, are forcing banks and other financial institutions to make huge write downs that are simply, mathmateically, never going to materialize. This is putting enormous pressure on capital requirements and forcing banks to curtail lending as they horde their case to keep their capitalization ratios liquid. In fact, it is driving banks to far exceed their current standards for "well capitalized" by 30 to 40% to protect against any future write downs as the market continues to deteriorate.

This hording of money and lack of lending is fueling the crisis by not allowing many qualified borrower's to obtain loans they need to escape the poor loans that they got a few years ago (For example...someone with an ARM they got at 6% three years ago could be forced to pay an 11% rate now when they should qualify for even as risk adjusted rate of, say, 8%). This is driving more defaults, more forebearance, and more loan modification...which of course provides more uncertainty to the market.

The solution is clearly a mark to model adjustment for mortgage backed assets. Equally clear is the need for proper assesment of the assets in these securities to be fed into the models. If a loan is a dog, then call it a dog...don't try to dress it up as a princess!!

If anything is a myth, it is the current forced write downs on these instruments that is being considered a prudent financial step. It is simply ridiculous!

If you have long term money to invest, imho, put it in the big bank stocks. In the next five years you will see HUGE returns as these assets perform much more closely to model than they do to current market prices. When they do perform, then you will begin to see the return of the secondary market and huge write ups and profit taking by the big boys!