Post by docfung on Nov 5, 2007 20:26:43 GMT -6
The 1987 Crash -- a Dress Rehearsal?
By Sham Gad November 5, 2007
On Oct. 19, 1987, a.k.a. Black Monday, the Dow dropped by 508 points, or 22.6%, making it one of the worst days in stock market history. For that to occur again today, the Dow would have to decline by more than 2,600 points. A decline of such magnitude seems highly unlikely, but if mortgages continue to deteriorate at such an accelerating pace, the result could make Black Monday seem like a dress rehearsal.
Suddenly, many supposedly smart individuals are starting to realize that they did not understand the risks of the structured deals they were involved in. Look no further than Merrill Lynch (NYSE: MER) to see what I mean.
Merrill Lynch has become ground zero when it comes to mortgage problems. It holds the record for the largest write-down in the financial world: some $8.4 billion. This loss is even more shocking because several weeks ago the firm predicted that total writedowns would equal $4.5 billion.
Oops. They were off by some $3.4 billion. I for one believe that the brass at Merrill is a rather intelligent group, but when it comes to the bundling, re-bundling, and re-re-bundling of pools of mortgages, it's about impossible for anyone to truly understand the risks involved. A close look at one deal reveals just how toxic and tainted they are.
Meet GSAMP Trust 2006-S3
By most measures today, this $494 million securitized pool of second mortgages was a drop in the bucket of the nearly half trillion dollars or so of mortgage-backed securities issued in 2006. GSAMP was sold by Goldman Sachs (NYSE: GS) and originally stood for Goldman Sachs Alternative Mortgage Products.
GSAMP comprised more than 8,000 second-mortgage loans, or loans taken as collateral for your first mortgage. In other words, the equity in the first mortgage was being funded by another mortgage. The average real equity in this pool of loans was 0.71%. The loan resembled more than 99% of the value of the home.
On top of that, 58% were no-documentation loans. To bring this all home: For almost no money down and no proof of income, you could own a $250,000 home. How easy is that? You can see why borrowers were in such a hurry for the loans. You were essentially buying a house with no money at risk. If home prices rose, you were fine. If prices fell and you were unable to make your payment, well, you just walked away having lost virtually nothing out of pocket.
Let the games begin
To sell this batch of mortgages, the issuer (in this case Goldman) pooled them and sliced them into tranches, or various pieces, to satisfy every investor's desire and appetite for risk. The top tranche is assured of first payment and is given the coveted AAA rating. On down the line we go, with each subsequent tranche being paid next, receiving a lower rating, and a higher interest rate. Just like that, a security is backed by mortgages taken out by individuals who have zero incentive to make mortgage payments that would back the securitization pool, and it is rated AAA. Leave it to Wall Street to take a toad and dress it up as a prince.
The next question is: How could the sophisticated buyers of securities such as the GSAMP Trust know how safe and sound they are? There were two ways: either read the several-hundred pages of the prospectus and related documents, or rely on the credit rating agencies -- Moody's (NYSE: MCO) and Standard & Poor's, which is a unit of McGraw-Hill (NYSE: MHP).
Guess which option was used just about every time. Even if investors choose to read through the documents, they still didn't get all the facts, because most issuers don't reveal borrowers' identities. So the rating agencies didn't have all the information either.
While the individual loans in the Goldman pool were toxic, 68% of the issue was rated AAA by both rating agencies. Apparently, issues backed by second mortgages of subprime borrowers were as secure as U.S. Treasury bonds.
To be fair, this particular securitization was one of the worst. But with $500 billion in mortgages issued last year alone, there are probably many of them that are not far behind the GSAMP Trust. They are set up so investors cannot value them appropriately. Nor can the rating agencies.
And given the $3.5 billion margin of error at Merrill Lynch, it appears the companies themselves can't accurately measure the extent of risk of these securitized pools. It is not difficult to see how Buffett dubbed derivatives "financial weapons of mass destruction."
httpMarkets fear banks have $1 trillion in toxic debt
By Sean O’Grady, Economics Editor
Published: 06 November 2007
A new phase in the credit crunch, one of “$1 trillion losses” seems to be dawning. The crisis at Citigroup and renewed doubts about some of the world’s leading banks disquieted stock markets on both sides of the Atlantic yesterday, with the fractious mood set to continue.
The FTSE 100 fell 69.2 to 6,461.4, with Alliance & Leicester (down 4 per cent) and Barclays (off 3 per cent, to a two-year low) singled out for punishment. In New York, Citigroup, down |4.9 per cent to multi-year lows, weighed on the Dow Jones index, which fell 51.7, or 0.4 per cent, to 13,543.4. Merrill Lynch, Goldman Sachs and Lehman Brothers also dropped on speculation they face more writedowns on top of the $40bn (£19bn) announced in the past four months.
Bill Gross, the chief investment officer of Pacific Investment Management, said US mortgage delinquencies and defaults would rise in 2008. “There are $1 trillion worth of sub-primes, Alt-As [self-certified] and basically garbage loans,” he said, adding that he expects some $250bn in defaults. “We’ve only begun to see the pain from rising mortgage payments,” he added. Brian Gendreau, an investment strategist at ING, commented: “Financials are 20 per cent of the S&P 500 and if that sector doesn’t do well all bets are off. People just don’t know what’s on the balance sheets.”
The banks remain unwilling to lend to each other, preferring to rebuild their balance sheets and “hoard liquidity” to buttress themselves against any shocks from repatriating off-balance-sheet losses from their special investment vehicles (SIVs). However, this tightening up has led to a vicious circle. Making credit tougher has exacerbated the problems of struggling mortgage holders in America; default rates then rise and make the banks even more exposed to losses as credit agencies downgrade their assets. This seems to be what happened at Citigroup. The admission that it was unable to assure investors that a potential $11bn write-down for sub-prime mortgages would not grow has led to this fresh fit of extreme nervousness. Huge write-downs by Merrill Lynch ($7.9bn) and UBS ($3.4bn) have not helped.
Samir Shah at Landsbanki Securities said: “People thought most of the bad news had been priced in. It seems we’re entering a second phase of the credit squeeze. We’re going back to a place where liquidity is drying up and volatility is increasing.”
Barclays has seen its shares savaged. “There is a concern about the extent of the debts among the banks generally and who will be left holding the debt,” Richard Hunter, of Hargreaves Lansdown, said. “There’s a read-across to Barclays Capital. People are concerned about the exposure it has.” Profit growth at its subsidiary was “strong”, the bank declared last month, though it offered no comment yesterday.
Alliance & Leicester also suffered from vague rumours that it had turned to the Bank of England for emergency funding. An A&L spokesman offered this reassurance: “Each week in recent months, including last week, Alliance & Leicester has successfully raised the funds it requires. We have also continued our share buy-back programme.”
The Chancellor, Alistair Darling, also pleaded for calm. “We are experiencing an unparalleled period of financial uncertainty caused by the problems in the US housing market,” he said. “I believe that we can get through that. Many banks in this country have very strong balance sheets after years of making very good profits.”
Meanwhile, on the continent, newspaper reports named two German banks – WestLB and a small specialised bank for professional people – as possible next victims of the crisis.
Interesting? Click here to explore
news.independent.co.uk/business/news/article3132507.ec
By Sham Gad November 5, 2007
On Oct. 19, 1987, a.k.a. Black Monday, the Dow dropped by 508 points, or 22.6%, making it one of the worst days in stock market history. For that to occur again today, the Dow would have to decline by more than 2,600 points. A decline of such magnitude seems highly unlikely, but if mortgages continue to deteriorate at such an accelerating pace, the result could make Black Monday seem like a dress rehearsal.
Suddenly, many supposedly smart individuals are starting to realize that they did not understand the risks of the structured deals they were involved in. Look no further than Merrill Lynch (NYSE: MER) to see what I mean.
Merrill Lynch has become ground zero when it comes to mortgage problems. It holds the record for the largest write-down in the financial world: some $8.4 billion. This loss is even more shocking because several weeks ago the firm predicted that total writedowns would equal $4.5 billion.
Oops. They were off by some $3.4 billion. I for one believe that the brass at Merrill is a rather intelligent group, but when it comes to the bundling, re-bundling, and re-re-bundling of pools of mortgages, it's about impossible for anyone to truly understand the risks involved. A close look at one deal reveals just how toxic and tainted they are.
Meet GSAMP Trust 2006-S3
By most measures today, this $494 million securitized pool of second mortgages was a drop in the bucket of the nearly half trillion dollars or so of mortgage-backed securities issued in 2006. GSAMP was sold by Goldman Sachs (NYSE: GS) and originally stood for Goldman Sachs Alternative Mortgage Products.
GSAMP comprised more than 8,000 second-mortgage loans, or loans taken as collateral for your first mortgage. In other words, the equity in the first mortgage was being funded by another mortgage. The average real equity in this pool of loans was 0.71%. The loan resembled more than 99% of the value of the home.
On top of that, 58% were no-documentation loans. To bring this all home: For almost no money down and no proof of income, you could own a $250,000 home. How easy is that? You can see why borrowers were in such a hurry for the loans. You were essentially buying a house with no money at risk. If home prices rose, you were fine. If prices fell and you were unable to make your payment, well, you just walked away having lost virtually nothing out of pocket.
Let the games begin
To sell this batch of mortgages, the issuer (in this case Goldman) pooled them and sliced them into tranches, or various pieces, to satisfy every investor's desire and appetite for risk. The top tranche is assured of first payment and is given the coveted AAA rating. On down the line we go, with each subsequent tranche being paid next, receiving a lower rating, and a higher interest rate. Just like that, a security is backed by mortgages taken out by individuals who have zero incentive to make mortgage payments that would back the securitization pool, and it is rated AAA. Leave it to Wall Street to take a toad and dress it up as a prince.
The next question is: How could the sophisticated buyers of securities such as the GSAMP Trust know how safe and sound they are? There were two ways: either read the several-hundred pages of the prospectus and related documents, or rely on the credit rating agencies -- Moody's (NYSE: MCO) and Standard & Poor's, which is a unit of McGraw-Hill (NYSE: MHP).
Guess which option was used just about every time. Even if investors choose to read through the documents, they still didn't get all the facts, because most issuers don't reveal borrowers' identities. So the rating agencies didn't have all the information either.
While the individual loans in the Goldman pool were toxic, 68% of the issue was rated AAA by both rating agencies. Apparently, issues backed by second mortgages of subprime borrowers were as secure as U.S. Treasury bonds.
To be fair, this particular securitization was one of the worst. But with $500 billion in mortgages issued last year alone, there are probably many of them that are not far behind the GSAMP Trust. They are set up so investors cannot value them appropriately. Nor can the rating agencies.
And given the $3.5 billion margin of error at Merrill Lynch, it appears the companies themselves can't accurately measure the extent of risk of these securitized pools. It is not difficult to see how Buffett dubbed derivatives "financial weapons of mass destruction."
httpMarkets fear banks have $1 trillion in toxic debt
By Sean O’Grady, Economics Editor
Published: 06 November 2007
A new phase in the credit crunch, one of “$1 trillion losses” seems to be dawning. The crisis at Citigroup and renewed doubts about some of the world’s leading banks disquieted stock markets on both sides of the Atlantic yesterday, with the fractious mood set to continue.
The FTSE 100 fell 69.2 to 6,461.4, with Alliance & Leicester (down 4 per cent) and Barclays (off 3 per cent, to a two-year low) singled out for punishment. In New York, Citigroup, down |4.9 per cent to multi-year lows, weighed on the Dow Jones index, which fell 51.7, or 0.4 per cent, to 13,543.4. Merrill Lynch, Goldman Sachs and Lehman Brothers also dropped on speculation they face more writedowns on top of the $40bn (£19bn) announced in the past four months.
Bill Gross, the chief investment officer of Pacific Investment Management, said US mortgage delinquencies and defaults would rise in 2008. “There are $1 trillion worth of sub-primes, Alt-As [self-certified] and basically garbage loans,” he said, adding that he expects some $250bn in defaults. “We’ve only begun to see the pain from rising mortgage payments,” he added. Brian Gendreau, an investment strategist at ING, commented: “Financials are 20 per cent of the S&P 500 and if that sector doesn’t do well all bets are off. People just don’t know what’s on the balance sheets.”
The banks remain unwilling to lend to each other, preferring to rebuild their balance sheets and “hoard liquidity” to buttress themselves against any shocks from repatriating off-balance-sheet losses from their special investment vehicles (SIVs). However, this tightening up has led to a vicious circle. Making credit tougher has exacerbated the problems of struggling mortgage holders in America; default rates then rise and make the banks even more exposed to losses as credit agencies downgrade their assets. This seems to be what happened at Citigroup. The admission that it was unable to assure investors that a potential $11bn write-down for sub-prime mortgages would not grow has led to this fresh fit of extreme nervousness. Huge write-downs by Merrill Lynch ($7.9bn) and UBS ($3.4bn) have not helped.
Samir Shah at Landsbanki Securities said: “People thought most of the bad news had been priced in. It seems we’re entering a second phase of the credit squeeze. We’re going back to a place where liquidity is drying up and volatility is increasing.”
Barclays has seen its shares savaged. “There is a concern about the extent of the debts among the banks generally and who will be left holding the debt,” Richard Hunter, of Hargreaves Lansdown, said. “There’s a read-across to Barclays Capital. People are concerned about the exposure it has.” Profit growth at its subsidiary was “strong”, the bank declared last month, though it offered no comment yesterday.
Alliance & Leicester also suffered from vague rumours that it had turned to the Bank of England for emergency funding. An A&L spokesman offered this reassurance: “Each week in recent months, including last week, Alliance & Leicester has successfully raised the funds it requires. We have also continued our share buy-back programme.”
The Chancellor, Alistair Darling, also pleaded for calm. “We are experiencing an unparalleled period of financial uncertainty caused by the problems in the US housing market,” he said. “I believe that we can get through that. Many banks in this country have very strong balance sheets after years of making very good profits.”
Meanwhile, on the continent, newspaper reports named two German banks – WestLB and a small specialised bank for professional people – as possible next victims of the crisis.
Interesting? Click here to explore
news.independent.co.uk/business/news/article3132507.ec