Marginal Utility

by Ken Houghton

Yes, this post is snarky, but BSC formed a "work-out" team back in January/February of 2007—and then appears to have downsized most of them just as the HOPE NOW program was initiated.

So when we see at Housing Wire that Bear—the #2 originator of MBS—is short $1 billion worth of securities, after having been long $1 billion in August, is it possible that this is the light at the end of the tunnel?

Or just sleight of hand, as the Bloomberg article notes:

In an interview after Molinaro's remarks, Bear Stearns spokesman Russell Sherman said the New York-based firm's subprime trades are a "hedge" against potential losses on investments in higher-rated mortgages, he said.

"We are using short positions to offset other long positions in our mortgage inventory," Sherman said. He didn't provide details on specific trades.

Nor should he. But the implication is that they are short the securities that have a chance of appreciating, and long securities that have nowhere to go but down.

So maybe it's not an indicator at all. 2010 is looking more and more as if it will be something other than The Year We Make Contact. (R.I.P. Roy Scheider)

Labels: mortgage, subprime, The Old Firm

by Ken Houghton

I've been trying to get through the 232 pages of preliminary AEA programming. I may just decide to sleep in Saturday morning:

Jan. 5, 8:00 am

The Subprime Mortgage Crisis

Presiding: To be announced.

ALAN BLINDER, Princeton University
PAUL KRUGMAN, Princeton University
NOURIEL ROUBINI, New York University
ROBERT SHILLER, Yale University

Labels: Economics, mortgage, subprime

by Ken Houghton

The Sainted Tanta decides not to pick just on "Relitters," and goes after a senior fellow in economic history at the Council on Foreign Relations" who writes an op-ed for Bloomberg "which may possibly be one of the most ridiculous things I've read in nearly a whole week."

I make the mistake of following the link, wondering if, for once, I was going to defend an economist.

Then I found out it was Amity Shlaes.

Never mind.

Labels: Economics, mortgage, subprime

by Ken Houghton

UPDATE: Yves Smith at Naked Capitalism corrects some of my data errors and delves a bit deeper. (See also Tom's comment.)

With the help of the now-free-if-you-Digg-It (h/t Felix) WSJ, let us see if we can rationalize some numbers.

There is a projection of 2 million (2E6) foreclosures (corrected, thank you Anonymous here) in the mortgage market over the next few years. Since most of those seem to be described as "subprime," it is reasonable to assume that they will mostly be non-Jumbo, Fannie/Freddie-eligible mortgages. That currently means their value (of the mortgage that is, not the house) is capped at $417,000. (4.17E5).

Now 4.17 x 2 = 8.34, so we are talking—absolute worst case—$8.34E11, or $834 billion. And that's if the home and the land are all worth zero, everyone took a maximum mortgage, and all two million foreclosures (corrected; see above) happen. Over the next several years.

I think we can agree that the above should be the worst-case scenario. (Even if the properties are all on Lon Gisland, that should still leave at least 50% of the value intact.)

Now, it's entirely possible that the WSJ and I have missed a few firms. But I believe most of the large ones, including Swiss Re today (h/t Calculated Risk) are represented below:



By my (and Excel's) math, assuming the Absolute Worst Case Scenario being Discussed, just under 7.8% of the Total Possible Value of the pending foreclosures (ibid.) has already been written off.

Now, I'll readily concede that some of those writeoffs may have been excessive, though Tanta makes the reasonable case (while b*tch-sl*pp*ng a deserving Peter Eavis) that there isn't much of a range of GAAP options. Some, though, may have just been the tip of the iceberg. (FYI, I have tried to keep CDO/CDS writeoffs out of the calculations.) So if we start restricting the model (assume that not all loans were for the maximum amount, or that there is residual value in the property and/or loan after foreclosure), that just-under-8% starts looking more and more as if a large share of the losses are already accounted for, with the worst yet to come.

(Please, those of you who are solvent, hit the Calculated Risk tip jar.)

So the most reasonable assumption (Entia non sunt multiplicanda praeter necessitatem) is that one of the inputs to the model is incorrect.

Note that the "model" has only two inputs to reach that $834B maximum:

1. The maximum amount a GSE such as Fannie covered since 2006 is certain, and it was never higher than that for Single-Family mortgages.
   
   
2. So that leaves the 2,000,000 expected housing foreclosures in the next few years. If you think the worst is yet to come, and you expect that the write-downs are not going to cover the entirety of the problem (some of those MBSes are stuffed into Jim Hamilton's pension fund (link added), for instance—and probably yours and mine, too), then this is the likely candidate for change.

If we believe what the banks are doing, and not what they may be saying, then that Goldman Sachs projection about the effect on collateral securities such as CDOs may look optimistic.

Unless I'm missing something, which is entirely possible. Anyone?

Labels: bankruptcy, credit, mortgage, subprime

by Ken Houghton

Tanta at Calculated Risk explains that one judge believes in the Rule of Law, and, in Footnote 3, understands and explains why it exists.

The price of freedom is eternal vigilance. Good to see someone who still believes that.

Labels: Calculated Risk, Moral Hazard, mortgage, subprime

by Ken Houghton

from Moody's September 2007 Subprime Mortgage Market Update, as cited by Tanta at CR:

Interestingly, FICO scores and LTV ratios do not vary significantly between the strongest and weakest performing transactions and on average transaction performance does not appear to have been influenced by these characteristics.

If the sentence didn't include that adverb at the beginning, would you look up and say, "Interesting..." at the end of reading it?

Or would you say, "That's obvious. As Felix Salmon noted, '[Y]our mortgage is pretty much the last thing you're going to default on.' Loan-to-Value has nothing to do with whether you can pay your mortgage, and FICO is going to be at best a lagging indicator.

"The idiocy was in attributing all-seeing power to those factors in the first place."

Labels: Calculated Risk, mortgage, subprime

by Anonymous

"How to Improve Your Child's Credit Rating."

Because, you know, the subprime lending problem wouldn't be so bad if more 5-year olds were qualified for no-money-down mortgages.

Labels: Naked Capitalism, subprime, W$J

by Ken Houghton

Many distractions in the past week, including but not limited to the start of school for the Eldest Daughter, a cold, house renovations beginning, a tree branch falling on the swing set (no injuries, fortunately), and the need to study Drek's advice here.

So, a few things I might have wanted to discuss, but am now happy to relegate.

The Dustbin of History is a good idea:

Glenn Reynolds defines derivative, and, implicitly, what wasn't:

The here-doubtable Tyler Cowen suggests one should read Megan McArdle instead of Matt Yglesias, failing to note that it was one of "the former Jane Galt"'s idiocies that cued Matt's rant. (Apparently, in McArdle's world, politicans are perfectly neutral, since they say nothing they believe and therefore should never be taken at their word.* Having grown up with Lee Hamilton as my Congressman, I expect better, recent matters notwithstanding.) Fortunately, AngryBear and Mark Thoma beat this one severely into the ground, though Paul Krugman (h/t Thoma) lays to rest the idea that economic ideology alone is the issue.

Posts I Might Have Written:

I spent three days body surfing, and still have some cuts and bruises to prove it. It made me think about the mortgage market. Which means I'm quoting these lyrics:

Pick up here and chase the ride
The river empties to the tide
Fall into the ocean

The river to the ocean goes,
A fortune for the undertow
None of this is going my way...

Strength and courage overrides
The privileged and weary eyes...
Pick up here and chase the ride
The river empties to the tide
All of this is coming your way

Only in part because the alternative isn't a song we talk about on family blogs, though several subprime borrowers may find this more appropriate:

I am friend to the undertow
I take you in, I don't let go
And now I have you

Max has left the blogsphere; what is the opposite of "Pareto optimal"? A hearty "L'Shana Tovah!" to him, and change your bookmarks to the robust but unMaxed Econospeak.

My radio this morning produced Nachum interviewing NYC Mayor Michael Bloomberg. Bloomberg, who as a politician reminds me a lot of Bill Clinton (in his pre-mayor days, he sounded less convivial and more cocksure; it may just be age). He mentioned his 98-year-old mother trying to fast on Yom Kippur and fainting. "Mom, G-d doesn't want you not to eat and drink and take your pills, and this is his way of showing it." Especially now, we often forget that fasting on the Day of Atonement is waived for children and those whose health would be negatively impacted.

One way you can tell when an "economics paper" is written for a giggle: when the phrase "participants extended offers (albeit in Canadian dollars)" is used. Note to Dani Rodrik: I didn't bother checking the mathematics involved after hitting that sentence, and I suspect Matthew Dowd would have the same reaction.


*It is also necessary, for this model to have a chance of working, to assume that their policies also do not reflect their speeches or predelictions. For instance, George W. Bush mentioning several times, though in an offhand manner, during the run-up to the 2004 election that he wanted the government to address issues with Social Security must in no way have affected the political discussions of 2005-2006.

Labels: Angry Bear, Economics, Economists View, just life, mortgage, schools, subprime

// posted by Ken Houghton @ 11:42 PM 0 comments

by Ken Houghton

Coutesy of my Loyal Reader, a piece from the Daily Mail on worker satisfaction in The City:

More than 80 per cent of Goldman employees were either happy or neutral about their jobs.

The firm that performed worst in the poll was troubled global investment bank Bear Stearns - more than 73 per cent of respondents who work at the firm said they were either dissatisfied or wished to leave.

It is notable that the Fixed Income side of the firm has been expanding significantly in London over the past eighteen months, including acquisition of a couple of mortgage-related firms.

The defence:

But Bear Stearns said: "We have a great record for employee retainment and feedback from our staff is generally very positive.

"We have a strong climate and are making a lot of top quality hires as we grow."

Of course, they said that about the recent acquistion of Encore Credit too. That's working out:

Bear Stearns gave 100 employees their walking papers yesterday, according to CNN Money. The cuts hit Bear’s subprime unit, Encore Credit. Headhunters say that more cuts are on the way thanks to the recent “meltdown” in financial markets....

With more to come?

Alan Johnson, managing director of Johnson Associates, a New York compensation consulting firm, expects layoffs in the mortgage and structured products divisions of the big banks before the end of the year.

There will be some good people available if that's true. But demand for those specific skills will probably be down.

UPDATE: BSRM takes a hit as well:

Encore Credit, based in Irvine, California, is eliminating 100 positions, and the Bear Stearns Residential Mortgage Corp. division in Scottsdale, Arizona, is reducing its workforce by 140, said the person, who declined to be identified because the number of jobs isn't being released publicly.

elicits the "non-defence":

"In the normal course of business Bear Stearns Residential Mortgage Corp. and Encore Credit evaluate market conditions and staffing levels in an effort to identify areas where we can eliminate redundancies and improve the efficiency of our operations," the New York-based firm said in an e-mailed statement today. "As a result we have made the decision to reduce our staffing levels and close two operation centers."

Encore was acquired late in 2006, with a significant number of their old staff electing severance instead of acquisition.

Can the EMC operations, centered in Dallas, be far behind?

Labels: High Finance, mortgage, subprime, The Old Firm

by Ken Houghton

Too good not to quote:

There's one very stupid way of doing this. Imagine you're a chicken. Every day, the farmer feeds you. After a while, you figure: "My returns from the farmer are pretty stable, as I seem to get roughly the same amount of corn every day. Being a chicken is a low-risk business."

The following day, the farmer breaks your neck.

Read the Whole Thing. After that, consider that Henry Paulson leaving his old job for his current one made both places worse.

Labels: High Finance, Optimal Resources, Statistics, subprime

by Ken Houghton

Tanta at CR excerpts this gem:

The holiday season in Cordell, Oklahoma, did not start off on a merry note back in 1987. Just a month shy of Christmas, Farmers National Bank of Cordell failed...

At Farmers’ closing, FDIC staff noticed an asset labeled “turkeys” on the bank’s books. When asked about the entry, bank employees directed the FDIC staff to a cold storage locker filled with frozen turkeys—literally thousands of them. The records about the turkeys’ ownership were incomplete, but bank employees assured the FDIC that the turkeys had been repossessed....

With the holidays drawing closer, the FDIC staff decided to spread some good cheer by donating the turkeys to a homeless shelter and food pantry in Oklahoma City. Christmas was certainly much brighter for many homeless people that year.

Somewhere, that year at least, Pretty Boy Floyd was smiling.

Labels: just life, Music, subprime

by Ken Houghton

There has been much discussion (often heated enough to cover Tom's household energy needs) about "marking to model." (Tanta at CR has been especially good on this issue.)

I have no conceptual problem with marking to model so long as (1) actual trading prices are not significantly different from the model and (2) the model used is consistent.

Apparently, the SEC is starting to share that last concern:

U.S. regulators are scrutinizing the books of Wall Street's largest investment banks amid questions they are hiding losses from subprime mortgages, people familiar with the inquiry said.

The Securities and Exchange Commission wants to see whether firms are calculating the value of subprime-mortgage assets on their books the same way they calculate those values for their brokerage clients, such as hedge funds.

Note that the same method doesn't require the same price. But especially assets that are Held for Sale (HFS) are supposed to be marked with the best information available. This may not have been happening:

Wall Street banks are in a sensitive period as turmoil in U.S. mortgage markets generate losses for investors and push some lenders into bankruptcy. Yet few investment banks have disclosed significant subprime losses in recent periods.

The scrutiny may also help pinpoint whether hedge funds accurately report their results to investors, the Journal reported, citing an unnamed source. Regulatory checks into how firms calculate values of certain assets could boost the accuracy of performance reports to investors. [emphasis mine]

The first rule of reporting losses is that you can survive if you detail the entire problem upfront. If you report an $8 million loss the first day and $4 million more the next, you'll run into more problems than if you report $12 million on Day 1.

Liquidity and Transparency: they're not just for text books any more.

Labels: hedge funds, High Finance, Moral Hazard, Personal Finance Advice of Alan Greenspan, principal/agent problems, subprime

by Ken Houghton

Just a brief note on this post from Barry Ritholtz and the folks at The Big Picture (h/t Dr. Black):

It took less than an hour—on a Saturday morning—for dblwyo to point out the obvious: the Fed's Discount Window is always open. But the Discount window has changed since the days when it was a discount loan of Last Resort:

The rule replaces adjustment credit, which currently is extended at a below-market rate, with a new type of discount window credit called primary credit that will be broadly similar to credit programs offered by many other major central banks. Primary credit will be available for very short terms as a backup source of liquidity to depository institutions that are in generally sound financial condition in the judgment of the lending Federal Reserve Bank. The Board expects that most depository institutions will qualify for primary credit.

Reserve Banks will extend primary credit at a rate above the federal funds rate, which should eliminate the incentive for institutions to borrow for the purpose of exploiting the positive spread of money market rates over the discount rate. The Board anticipates that the primary credit rate will be set initially at 100 basis points above the FOMC's target federal funds rate.

which means the current Discount Rate is 6.25.

In the old days (pre 9 Jan 2003), the Discount Rate was a legitimate discount (generally, iirc, about 3% below FedFunds). The alleged "incentive for institutions to borrow for the purpose of exploiting the positive spread" was more than mitigated by two things: (1) everyone knew you were doing it and (2) you had to explain to the Federal Reserve why you were doing it.

I interviewed once at a major money center bank that had, a year or so previously, been generally discussed as being on the brink of collapse. They had used the discount window six times in their worst year. So I view the talk of that "incentive" with a large barrel of salt.

What is real is that the "discount window" is now a Lender of Last Resort, with all the stigma and all of the information of the old Discount Window, and a higher interest rate.

So—as Jim Cramer should know—going to the Discount Window won't improve a financial institution's short-term cash flow problems; it will exacerbate them, both directly and indirectly. It's one of the improvements of the Federal Reserve made during the Bush Administration.

Jimmy Cayne, a major Bush supporter, undoubtedly knows that. That Jim Cramer didn't is sad.

Go read the whole thing at The Big Picture; check out the videos, listen to the remix. And mark Friday as the day that financial journalism—even in the context of Cramer's normal hyperbole—reached the level usually reserved for political reporters.

Labels: High Finance, Journamalism, Moral Hazard, subprime, The Old Firm

by Ken Houghton

1. Caroline Spector tries Starbuck's coffee:
   

   I met a friend at Starbucks the other day. I haven’t been in Starbucks since I quit drinking coffee. Not unlike the alcoholic who should stay away from bars, I found just being in a place so redolent of brewing Sweet Nectar of the Gods was more of a temptation than I could stand for the first year or so.
   
   My friend arrives and gets an iced coffee. Being the shameless mooch I am, I ask if I can have a sip of her enticing cold beverage. (Mmmmm, caffeine.) She graciously obliged.
   
   I take a sip. And then I have that moment we’ve all had, (girls more so than guys I suspect) the, “Do I spit or swallow?” dilemma. Because what I have in my mouth is not Sweet Nectar of the Gods, but rather Satan’s Piss.
   
   You know: The Devil’s Urine. Beelzebub’s tee tee. Lucifer’s pee. Mephistopheles’s piddle. This stuff is so foul I’m pretty sure they must have an EPA permit to sell it.
   
   And I realize why Starbucks sells all those Vente, Grande, Mocha Swirl with a Half-gainer concoctions. Because if anyone actually tasted the coffee in them, they would be convinced, as I am now, that Starbucks is actually in league with The Dark Lord (no, not Voldemort) to corrupt the taste buds of an entire generation.

   
   and then she discusses Harry Potter and the Deathly Hallows in a manner that (though I disagree with her conclusion) at least makes it clear she has a basis in reality.
   
   
2. Trying to find reality, Gavin Kennedy reviews Milton Friedman's "contribution" to Adam Smith's Legacy, finds he's the primary reason it is "lost":
   

   In the meantime, I am savvy enough to know from long experience of this misattribution to Smith of a metamorphosis of a metaphor into a ‘concept’, which he never meant it to be read that way, as my regular reader will know, that I could assume what follows, but scholastic training, and the many occasions when in discourse I have seen people caught for doing just that before falling on their faces, I shall refrain from the temptation, and await some kindly person to send me the paragraph..
   
   That Milton Friedman, of Chicago University fame, was behind the metamorphosis does not surprise me. ‘Chicago’ Adam Smith was created in Milton’s department and replaced the authentic ‘Kirkcaldy’ Adam Smith who wrote the Wealth Of Nations.
   
   One of the many atrocities committed by Chicago and its graduates who spread the word across US campuses, was the myth of the ‘invisible hand’, which some variants transmuted into ‘as if led by an invisible hand’, and most of examples of the myth in currency assert it was, first a ‘concept’, then a ‘theory’ and finally Smith’s most ‘important idea’.
   
   Should my reader wish to have an electronic copy of my recent paper, “Adam Smith’s Invisible Hand: from metaphor to myth”, he or she should let me know by arranging the following words into an address: ‘gavin’, ‘negweb’ and ‘com’ in the usual manner.

   
   UPDATE: Kennedy gets the full quote, and goes full out.
   
   
3. And—only somewhat related to either of the above but as a result of visiting a world more unreal than that of thestrals and Xenophilus Lovegood—Felix Salmon discovers that Punditry is for Professionals Only. Do not try this at home, especially if you are Sane:
   

   Just some of the Cramer gems there:
   

   "I'm looking for 100% default on the 2-and-28s. One hundred per cent. The bears are looking for 50%. I'm saying that they're foolish and that they're way too optimistic."
   
   "I'm not distinguishing any more between subprime and prime. That's a meaningless distinction. When your house drops 20% in value, then it doesn't matter whether you're subprime or prime. It's better to walk away, even if you're wealthy, because you don't want to lose your credit card, and you don't want to lose your car. Your house is the one thing that's fungible. It's smart to walk away... If your home declines 20% in value, it's really important to walk away from it."
   
   "I'm calling for a dramatic decline in home values... If the Federal Reserve were to cut rates by one full point, things would just reverse dramatically, and everything would go up in value... Until then, we're going to be in what I believe now is a total crisis."

   
   Is it worth responding to this as though it's rational? Is this what passes for informed commentary on TV these days? I can see how it gets ratings, in a train-wreck kind of way – hell, I'm blogging it. But the idea that wealthy people will stop paying their mortgages because their houses are "fungible" (unless we get a 100bp cut in the Fed funds rate, of course) – it's like some kind of incredibly unfunny parody. Nouriel Roubini et al might be shrill, but at least there's coherent logic to their position.

   
   Is it worth responding to Consummate Irrationality? Probably only at the margins, and there are days when the marginal return doesn't seem to be enough.
   
   
4. Bryan Caplan says something sensible on this anniversary of Friedman's death. (Of course, he discovered it at Comic-Con):
   

   My Comic-Con epiphany: Economics doesn't really have superstars. Even if Adam Smith himself showed up at the American Economic Association meetings, he wouldn't have thousands of economists fall on their knees in awe. But that's basically what happened at Comic-Con when Neil Gaiman held some public Q&A.

   
   Just wait until after Stardust comes out at the end of next week.
   
   
5. And, finally, from earlier this year, I honor The "Uncle Miltie" of Economics by referring you to Max's "discuss[ion of] Milton Friedman's leading contributions to economic thought" and its attendant links. So that his legacy may not be forgotten.

Labels: Eat Our Brains, Economics, mortgage, sf, subprime

by Ken Houghton

I posted a while back that there were arguably three successes in the top ten IPO issuances of all time (pre-Blackstone). It was arguable because:

the weakest of which—CIT Group—has a market cap about about twice its IPO

That may not be true for long (h/t comments at Calculated Risk):

CIT Group Inc., the largest independent commercial finance company in the U.S., reported an unexpected second-quarter loss and said it's getting out of home lending. The shares had their biggest drop in almost five years....

Chief Executive Officer Jeffrey Peek decided to quit the home-loan business, which accounts for about 10 percent of CIT's income, after losses rose more than expected and investor demand for mortgages waned. The unit focused on "subprime" borrowers with weak credit or heavy debts, a category where loans are souring nationwide at the fastest pace since 2002.

The loss "blindsided the market," said a report by Royal Bank of Scotland credit analysts including Corinne Cunningham. "CIT has until now claimed to have a subprime book that was better than average."

That claim, of course, may still be true.

Labels: Economics, High Finance, mortgage, subprime, The Old Firm

by Ken Houghton

I'm disinclined to blame rating agencies, who are explicitly not fiduciaries, for delays in downgrading, largely because they will not have updated information so quickly as, say, the service provider or the owner of the securities.

However, closing the barn door after the horses escape is one thing; not knowing how to tell if the horses have escaped, or where the door is, is another.

Via Naked Capitalism, the FT discusses rating agency mis- or nonfeasance:

[Josh] Rosner [a consultant at research firm Graham Fisher} points to an April report from Moody's that showed the rating agency did not consider debt-to-income ratios as a primary piece of data in their mortgage models, although this is generally considered as one of the three key predictors of mortgage default.

In the same report Moody's said it would for the first time request loan level data detailing the structure of adjustable-rate mortgages, the servicer, the month of the first interest rate adjustment and other data that would allow them to analyse risks. S&P admitted this week that it does not receive this kind of granular data on performance of individual loans within the mortgage pools backing the bonds that it rates.[emphasis mine]

Anyone interviewing for a job as an MBS analyst who didn't mention most of the above would not get a second interview. Except, apparently, at Moody's.

There still should be other agents acting first. (The most reasonable argument against regulation is that, by the time regulators have the information, the problem may be being solved.) But rating agencies are at worst the last resort of the small investor.

One revelation that analysts have described as "extraordinary" this week is that S&P has no specific estimate of how much turmoil in the housing market would be needed to force downgrades of the AAA and AA ratings that have been left untouched in this round of downgrades and constitute the bulk of the principal value of most mortgage-backed deals. Moody's also said in an interview that it had no such estimate.

Oh, well. So much for that theory?

Labels: fiduciary responsibility, Moral Hazard, mortgage, subprime

by Ken Houghton

Felix Salmon gives a briefing of how difficult it would be to show collusion in CDOworld. Select excerpts:

Firstly, the big banks are not generally big holders of CDO tranches. The whole reason why CDOs exist in the first place is that they're a mechanism for moving risk off the balance sheets of the sell side, and onto the balance sheets of the buy side.

English translation: Your pension fund is SNAFU.

Part of the reason is that they don't need to collude in order to hold on to their CDOs. CDOs, by their very nature, are a buy-and-hold investment. There's almost no liquidity in them, and the explicit tradeoff in the CDO market is that investors get a higher coupon by giving up liquidity.

The perversity of it is that in a vibrant market, you shouldn't have to buy a CDO. But that's another post.

You can't short something which never trades, and as far as I know no one is writing credit protection on CDOs. There are lots of people writing credit protection on MBSs, including subprime-backed MBSs, but they're a different instrument entirely.

This is why, all those posts ago, I compared this "meltdown" to the Structured Note market. I tried at one point to go short a Structured Note (don't ask) and cover it in the Repo market. After almost a full day, no one could find it. As with CDOs, the assumption is that you will Hold to Maturity. You bought it, you own it—even if it breaks.

And, most preciously:

One option is to address the general topic without quoting my question [presumably the post's title, "Why There Aren't Anti-Collusion Lawsuits in the CDO Mess," in question form) and without mentioning magic words like "antitrust" and "collusion."

Frankly, I'm not clever enough to answer this question without quoting it and without using the magic words.

It's arguably not collusion when everyone, working in their own self interest, does the same thing—just as it wasn't collusion when they bought the paper in the first place. And the glut of hedge funds created in recent years makes it fairly clear that a "barriers to entry" argument will fly about as well as, say, Amaranth did late last year.

If I were thinking lawsuit, I'd be using terms such as "fiduciary responsibility" and "prudent" and looking at mutual fund investments in hedge funds: low-hanging fruit may not be the tastiest, but it is the most accessible.

Labels: Antitrust, Economics, fiduciary responsibility, hedge funds, subprime

by Ken Houghton

I was thinking about a long response to Brad's comment when I quoted Dr. DeLong here:

The "As long as..." is there for a reason. If defaults trigger foreclosures and if dumping foreclosed houses onto the real estate market triggers a steep price decline in the underlying, we're in big trouble. If not, not, IMHO...

It was going to be a discussion of price versus value, and the danger to market players and makers of having to choose between (1) still being able to "mark to model," (2) taking the exposure of marking their portfolios at one price and their custodial holdings at another, or (3) remarking everything based on the benchmark trading levels established in the collateral selloffs.

Note especially that none of the above options requires the underlying assets to be foreclosed or defaulted; the question is one of price, not value.

Fortunately, I am lazy and the reason no one wants to use option 2 or 3 is becoming clear, as noted at Mish's:

The situation is so bleak that Bear Stearns' asset management group is suspending redemptions at the onetime $642 million fund—meaning investors have no choice but to sit on their losses. And that's got some hopping mad.

An investor in Europe, who didn't want to be identified, says he's been trying to get his money out of the hedge fund since February.

He's particularly incensed that on a June 8 conference call the fund's managers set up to discuss performance, Bear Stearns officials refused to field investors' questions. "They specifically said they weren't taking any questions," says the investor. "They didn't want to say anything."

A Bear Stearns spokesman declined to comment.

As I noted at Felix Salmon's place, it takes more than a week to hire a Jeffrey Lane.

While I desperately hope I'm wrong, it looks more and more as if any legitimate investigation of the no-longer-planned Everquest IPO would produce results to make Arthur Anderson's relationship with Enron look positively arm's-length.

Labels: corporate malfeasance, Moral Hazard, mortgage, Regulation, subprime, The Old Firm

by Ken Houghton

(Moved up due to addition of Part II, below)

This is the closest I'm going to come to saying anything directly about The Old Firm: If things had been done differently at the time of LTCM, we might not be talking about Bear so much right now. Via Naked Capitalism, this Bloomberg Exclusive:

Bear Stearns Cos. is getting a taste of its own medicine.

It was Bear Stearns, the biggest broker to hedge funds, that nine years ago declined to join 14 other investment banks in the bailout of Long-Term Capital Management LP. Then last week, as New York-based Bear Stearns pleaded for help to rescue two of its hedge funds teetering on the brink of collapse, many of the same firms refused to come to its aid.

Merrill Lynch & Co., which pumped $300 million into LTCM, said no and seized $850 million of bonds held as collateral for loans it had made to the funds. Lehman Brothers Holdings Inc., JPMorgan Chase & Co. and Cantor Fitzgerald LP also pulled out, leaving Bear Stearns to sort through the wreckage of bad bets on subprime mortgage bonds and collateralized debt obligations.

As I noted previously, there is good reason that Bear trades lower than its comps. "[T]he most sharp-elbowed culture on the Street" may be a competitive advantage, but then there are the (rare?) times when "collegial" is more important than competitive—most often, in a time of crisis.

PART 2: There was, of course, a time when Cayne thought differently, as noted in When Genius Failed:

Labels: hedge funds, Market Failures, Naked Capitalism, subprime, The Old Firm

by Ken Houghton

I'm not saying anything. But the pieces should give you a better picture of what hedge funds do than Tyler Cowen is wont to present (via DeLong).

Not to mention this.

UPDATE: Tanta at CR provides a helpful summary.

Labels: Brad DeLong, Economics, hedge funds, Moral Hazard, mortgage, subprime, The Old Firm