Re: Plan's Basic Mystery: What's All This Stuff Worth?
- From: "Vanden" <vanbussche@xxxxxx>
- Date: Thu, 25 Sep 2008 12:43:44 -0400
Lacking a market, one solution might be to measure the value using the
so-called discounted cash flow approach, says Colum Chan, chief investment
officer at CC Investments. Here, analysts can estimate how much cash the
investments will generate each year as mortgage borrowers continue to make
their payments, then adjust those cash flows based on the interest rate a
buyer would demand to be paid for taking the risk.
This method, used by some stock and bond investors, would allow the
government to estimate the value of the securities and perhaps pay a
reasonable price, which the market is unable to pay due to excessive fear of
the unknowns, he says. "If the government sells when things start calming
down, taxpayers might end up winning in this one," he says.
from:
"Pricing mortgage-backed securities will be tough"
http://www.usatoday.com/money/industries/banking/2008-09-23-toxic-paper-bailout_N.htm
"Rita" <Rita@xxxxxxxxxxx> wrote in message
news:dcend4h1ou05tulii28e9h0n16f7p9db7h@xxxxxxxxxx
For those of us who have been wondering what the government will
get in exchange for acquiring the toxic assets, seems the answer
is "who knows?"
I say do the damn thing in stages so what they are buying can be
evaluated before committing to the entire $700 billion.
The New York Times
September 25, 2008
Plan's Basic Mystery: What's All This Stuff Worth?
By VIKAS BAJAJ
What would you pay, sight unseen, for a house that nobody wants, on a
hard-luck street where no houses are selling?
That question is easy compared to the one confronting the Treasury
Department as Washington works toward a vast bailout of financial
institutions. Treasury Secretary Henry M. Paulson Jr. is proposing to
spend up to $700 billion to buy troubled investments that even Wall
Street is struggling to put a price on.
A big concern in Washington - and among many ordinary Americans - is
that the difficulty in valuing these assets could result in the
government's buying them for more than they will ever be worth, a step
that would benefit financial institutions at taxpayers' expense.
Anyone who has tried to buy or sell a house when the market is
falling, as it is now, knows how difficult it can be to agree on a
price. But valuing the securities that the Treasury aims to buy will
be far more difficult. Each one of these investments is tied to
thousands of individual mortgages, and many of those loans are going
bad as the housing market worsens.
"The reality is that we are not going to know what the right price is
for years," said Andrew Feltus, a bond portfolio manager at Pioneer
Investments, a mutual fund firm based in Boston. "It might be 20 cents
on the dollar or 60 cents on the dollar, but we won't know for years."
While prices of most stocks are no mystery - they flicker across PCs
and televisions all day - the troubled investments are not traded on
any exchange. The market for them is opaque: traders do business over
the telephone, and days can go by without a single trade.
Not only that, many of these instruments are extremely complex.
Consider the Bear Stearns Alt-A Trust 2006-7, a $1.3 billion drop in
the sea of risky loans. Here's how it worked:
As the credit bubble grew in 2006, Bear Stearns, then one of the
leading mortgage traders on Wall Street, bought 2,871 mortgages from
lenders like the Countrywide Financial Corporation.
The mortgages, with an average size of about $450,000, were Alt-A
loans - the kind often referred to as liar loans, because lenders made
them without the usual documentation to verify borrowers' incomes or
savings. Nearly 60 percent of the loans were made in California,
Florida and Arizona, where home prices rose - and subsequently fell -
faster than almost anywhere else in the country.
Bear Stearns bundled the loans into 37 different kinds of bonds,
ranked by varying levels of risk, for sale to investment banks, hedge
funds and insurance companies.
If any of the mortgages went bad - and, it turned out, many did - the
bonds at the bottom of the pecking order would suffer losses first,
followed by the next lowest, and so on up the chain. By one measure,
the Bear Stearns Alt-A Trust 2006-7 has performed well: It has
suffered losses of about 1.6 percent. Of those loans, 778 have been
paid off or moved through the foreclosure process.
But by many other measures, it's a toxic portfolio. Of the 2,093 loans
that remain, 23 percent are delinquent or in foreclosure, according to
Bloomberg News data. Initially rated triple-A, the most senior of the
securities were downgraded to near junk bond status last week. Valuing
mortgage bonds, even the safest variety, requires guesstimates: How
many homeowners will fall behind on their mortgages? If the bank
forecloses, what will the homes sell for? Investments like the Bear
Stearns securities are almost certain to lose value as long as home
prices keep falling.
"Under the current circumstances it's likely that you are going to
take a loss on these loans," said Chandrajit Bhattacharya, a mortgage
strategist at Credit Suisse, the investment bank.
The Bear Stearns bonds are just one example of the kind of assets the
government could buy, and they are by no means the most complicated of
the lot. Wall Street took bonds like those of Bear Stearns and bundled
and rebundled them into even trickier investments known as
collateralized debt obligations, or C.D.O.'s
"No two pieces of paper are the same," said Mr. Feltus of Pioneer
Investments.
On Wall Street, many of these C.D.O.'s have been selling for pennies
on the dollar, if they are selling at all. In July, Merrill Lynch,
struggling to bolster its finances, sold $31 billion of tricky
mortgage-linked investments for 22 cents on the dollar. Last November,
Citadel, a large hedge fund in Chicago, bought $3 billion of mortgage
securities and other investments for 27 cents on the dollar.
But Citigroup, the financial giant, values similar investments on its
books at 61 cents on the dollar. Citigroup says its C.D.O.'s are
relatively high quality because they were created before lending
standards weakened in 2006.
A big challenge for Treasury officials will be deciding whether to buy
the troubled investments near the values at which the banks hold them
on their books. That would help minimize losses for financial
institutions. Driving a hard bargain, however, would protect
taxpayers.
"Many are tempted by a strategy of trying to do both things at once,"
said Lawrence H. Summers, a former Treasury secretary in the Clinton
administration. As a hypothetical example, Mr. Summers suggested that
an institution could have securities on its books at $60, but the
current market price might only be $30. In that case, the government
might be tempted to come in at about $55.
Many financial institutions are so weak that they must sell their
troubled assets at prices near the value on their books, Carlos
Mendez, a senior managing director at ICP Capital, an investment firm
that specializes in credit markets. Anything less would eat into their
capital.
"Depending on your perspective on the economy, foreclosure rates and
home prices, the market may eventually reflect that price. But most
buyers are not willing to make that bet right now," he said. "And
that's why we have these low prices."
Ben S. Bernanke, the chairman of the Federal Reserve, told Congress on
Tuesday that the government should avoid paying a fire-sale price, and
pay what he called the "hold-to-maturity price," or the price that
investors would bid if they expected to keep the bond till it was paid
off.
The government would buy the troubled investments with the intention
of eventually selling them back to the market when prices recover.
The Treasury has suggested it might conduct reverse auctions to
determine the price for securities that are not trading in the market.
Unlike in a traditional auction in which would-be buyers submit bids
to the seller, in a reverse auction the buyer solicits bids from
would-be sellers. Often, the buyer agrees to pay the second-highest
bid submitted to encourage sellers to compete by lowering their bids
for all the assets submitted. The buyer often also sets a reserve
price and refuses to pay any more than that price.
But Mr. Paulson told Congress on Tuesday that the government would use
many other means in addition to auctions, suggesting that it would
exercise wide discretion over the final prices to be paid.
Financial institutions will have an incentive to sell their worst
assets to the government, a risk that the Treasury will have to guard
against, said Robert G. Hansen, senior associate dean at the Tuck
School of Business at Dartmouth College.
"I am worried that the people who are going to offer the securities to
the government will be the ones that have the absolute worst toxic
waste," Professor Hansen said. Even so, he added, the government could
actually make a profit on its purchases - provided the Treasury buys
at the right prices. Richard C. Breeden, a former chairman of the
Securities and Exchange Commission, said the auctions could thaw parts
of the markets that have been frozen since late last year.
"One of the problems that many institutions are having is finding any
bid for some of these assets, even though they are not without value,"
said Mr. Breeden, who is chairman and chief executive of Breeden
Capital Management, an investment firm in Greenwich, Conn.
"What are these assets worth?" asked Mr. Breeden. "Sometimes, because
of fear or extreme uncertainty in the markets, you get in a situation
in which there are no bids at all, or at least no realistic bids."
Edmund L. Andrews contributed reporting.
.
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