Lehman

[Asher]

Less posts, more porting ESPN leagues to Yahoo.

[snoopy369]

Haha, i'll do that sometime today if I don't forget...

[PLATO]

Originally posted by snoopy369
Plato, correct me if I'm wrong, but IIRC the problem is that a lot of institutional investors have rules about their risk - ie, 'risk must be <5%' or something like that. When the bond's risk goes up, they have to dump it in order to stay within the bounds they are required to. This is not the fault of the mortgage industry per se, but of the secondary market.

This is essentially correct. Part of the problem with the seconday market being pretty much non-existent right now is that the institutional investors are stuck with what they have. In order to try and mitigate the risk they are purchasing credit default swaps. The major problem with this is that the people they are purchasing them from are major holders of the MBS that are in question and thus they have their own liquidity issues. It has become an intertwined house of cards.

I am generally very much against regulation, but in this case it needs to be instituted. At this point, the lack of regulation has everybody scarred to death simply because noone has any idea what their own exposure looks like let alone anybody elses. If they started today, it would take a minimum of 3-5 years to unwind all these deals in any kind of orderly fashion.

This is the main reason that institutionals are running for treasuries...they have no clue what their actual risk is, but they feel like treasuries mitigates some.

I don't think anyone's accusing the primary mortgage industry of causing this, except that they offered credit where they shouldn't have; but even then, they offered it because there was a market to sell the mortgages to. If the institutions (and the raters) had been more careful to evaluate the risk on these mixed instruments, there would have been fewer high risk mortgages sold, and no massive collapse.

This is very true. The brokers and loan officers had little choice but to sell what was available if they wanted to stay in business. Some companies exercised more restraint than others to be sure, but at some lkevel you either played ball or went home.

[Asher]

Originally posted by snoopy369
Haha, i'll do that sometime today if I don't forget...

I'll be sure you don't forget.

I can't even remember who I drafted...

[Kidlicious]

Originally posted by PLATO
There is definately something wrong with how bonds were being rates. So many of these never had due diligence done on them by the rating companies. The issuers would send it to the raters with a notation like "80%AAA 10%AA 8%BBB 2% residuals". The rating firms would say "Okay" and never even look at it...trusting the issuer to be reliable in what they were sending.

Either the issuers were blinded by their own greed, stupid beyond belief, or just plain criminally greedy is a question that still remains unanswered. The ratings are one of the fundamental unerlying causes of what we are experiencing.

But what you seem to be saying is that there are lower rated bonds that should be higher rated. It seems that way to me because you are saying that they have an actual value (based on what, admittedly I can't figure out), that is higher than what the bond rating would otherwise dictate.

[snoopy369]

Kid, you're missing the point. The point is not the value of the bond at all. The investors care about the uncertainty of the ratings, because they are required to carry a low amount of risk on their portfolios. Even if the far majority of these bonds are perfectly safe, the fact that a number of them are not is causing significant panic.

[DanS]

Fact is that there are those with money and the propensity to buy these assets, if they were priced appropriately. The likes of Warren Buffett would gorge themselves on these assets at the right price.

The markets are saying loudly that these assets are being mispriced hugely on the high side. Merrill couldn't even get proper buyers for 22 cents on the dollar.

[Kidlicious]

Originally posted by snoopy369
Kid, you're missing the point.

That's probably the case, however, something isn't making sense to me and no one has explained in a clear way.

The point is not the value of the bond at all. The investors care about the uncertainty of the ratings, because they are required to carry a low amount of risk on their portfolios. Even if the far majority of these bonds are perfectly safe, the fact that a number of them are not is causing significant panic.

This explaination doesn't cut it. I assume that "institutional investors can't carry more than x risk" means that they can only carry a limited amount of low quality bonds (meaning rating). What I don't understand is how you can call these bonds high quality (dispite the low rating). No one has answer that in laymens terms.

[snoopy369]

I'm a layman, and Plato explained it in terms I understood perfectly fine...

You are thinking in terms of "80% chance of success, $100m bond, so worth $80m". That's nice and theoretically accurate, but it is not how the institutional investors operate. These are the 'low-risk' folks, who manage government retirement funds and things like that. They guarantee a return, albeit a low one, and have rules regarding what they must carry in terms of risk - no more than a certain level of risk is acceptable. If the risk is more than a certain level, they have to get out in order to ensure the stability of their fund.

It's not "a certain number of low quality bonds", I imagine it's "no low quality bonds" or something similar. They no longer trust that their AAA bonds have a 95% return probability, or whatever, so they no longer are willing - or able - to be invested in these bonds. The uncertainty is in a sense part of the risk - but it's essentially just risk aversion. They are risk averse, so they must take no chances, while your average investor would look at the 93% return probability on a 10% return and say ".93*1.1 > 1".

[Colonâ„¢]

The whole point is people don't know how risky the securities are.

Uncertainty over risk = impossibility to determine price = no trading.

[Kidlicious]

Originally posted by snoopy369
I'm a layman, and Plato explained it in terms I understood perfectly fine...

No you don't. You can't even address my question. Why are the low quality bonds worth more than they are selling for and why don't large non-institutional buyers buy them up?

[snoopy369]

Kid, it's basic economics. Some people are risk-averse, and will undervalue risk; some are risk loving and will overvalue risk. These folks are risk-averse.

It's the standard question: Would you rather have a 50% chance at $1,000, or a 95% chance at $400? Some people choose B, even though it's less effective money. This is the same thing - these mortgage bonds might have a positive likely value, but the risk-averse institutional investors aren't willing to carry that risk.

[DanS]

Originally posted by Colonâ„¢
The whole point is people don't know how risky the securities are.

Uncertainty over risk = impossibility to determine price = no trading.

There are those who will take the chance at the right price, if the provisions in the assets are comprehensible.

[Kidlicious]

Originally posted by snoopy369
Kid, it's basic economics.

No it's not. It's finance. If it were economics I would have already wiped floor with both of you.

Some people are risk-averse, and will undervalue risk; some are risk loving and will overvalue risk. These folks are risk-averse.

You started off by saying that institutional investors have requirements regarding how much risk they can take. Does that mean that they can't buy more than X low quality bonds, or not? Why are you talking about basic principles of risk aversion now? You aren't making sense. Furthermore I'm suspicious that since you can't follow up on your initial point that you are turning to blaming people for not understanding principles when that's not the case at all.

[snoopy369]

Whatever you say, Kid. Whatever you say.

Kuci, you want another line in that sig of yours?