Sunday, November 4, 2007

Fear, Greed and Speculation: What really runs the market.

from the Wall Street Journal, with laser like analysis from yours truly...

Fresh Credit Worries Grip Markets

“"The situation is now more negative than in the summer," said Pete Nolan, a portfolio manager at Smith Breeden Associates in Chapel Hill, N.C. He said that "in many cases, the fundamentals are catching up" with investors' worst fears. The worry is that a huge financial edifice that is built on top of the now-shaky mortgage market could weaken, potentially causing lenders to tighten up on loans and slowing the economy. Translation: people (Wall St.) are now beginning to see how bad it really is...and they are scared.

In a recent report, analysts from J.P. Morgan Chase & Co. said they expect bank credit losses on mortgages and complex debt securities to continue well into 2008 as housing prices weaken further. As bank losses continue, we expect bank lending capacity to be reduced," they said, adding that banks will have to ration credit and are likely to favor lending to corporations over consumers…. Translation: Well into 2008? Try 2010! or '11! And bank "lending capacity"? Nil. Rationing credit simply means you'll be putting down 20% AND donating DNA

Besides the problems with banks and brokers, there was evidence of more problems in the mortgage market. Mortgage-servicing companies, which collect payments from borrowers, said delinquency and prepayment data were worse than expected. Translation: Cue the music! "...more problems in the mortgage markets" means IT'S BAD!! Delinquency and prepayment is worse than expected now, wait until 2008 when all those 2/5 ARM's break!

"Mortgages are still deteriorating at an accelerating pace, and that's scary," said Karen Weaver, global head of securitization research at Deutsche Bank AG. "We haven't come near a stabilization, and we expect things to get worse as the bulk of resets" of interest rates on adjustable-rate mortgages "have yet to come." The first line says it all.

The percentage of subprime mortgages -- those to home buyers with weak credit -- that were more than 60 days behind in payments topped 20% in August, up from 18.7% in July and 17.1% in June, according to the latest data from First American LoanPerformance. Like Ted Bundy once said, "add a zero" to that August number. No, he didn't say that, but you know what I mean.

Mark Zandi, an economist at Moody's, estimates that of the $2.45 trillion in especially risky mortgages currently outstanding -- including subprimes, interest-only loans, mortgages that exceed Fannie Mae lending limits and others -- as much as a quarter could suffer defaults in the months ahead. Total losses on these mortgages, he estimates, could reach $225 billion. That would hit bondholders hard, since the value of mortgage securities is driven by the performance of underlying mortgages. And it could make such bonds harder to sell in the future. Watch that $2.45 trillion and $225 billion go up in December. Watch!

Many expect the value of homes to continue to slip as well. Mr. Zandi puts the drop at 10%, from the market's peak in the fourth quarter of 2005 to its projected bottom in the fourth quarter of 2008. Such a decline would wipe out more than $2 trillion in home values. That's less than the $7 trillion in stock wealth wiped out by the tech bust that began in 2000, but still would represent a significant hit to the economy. I pray to GOD that I'm wrong, but me thinks we might get very, very close to $7 trillion. I think alot of investors, punch drunk and stupid from the Dot Com bust, needed to make up some losses and hedged on the housing market to "right their ship". When the hits just kept on coming, they let the record play, scratches be damned.

Because mortgages are bundled into securities sold to investors all over the world, the deterioration in mortgages' value is having a wide effect. Many of the more complex securities, known as collateralized debt obligations, or CDOs, are held by banks and brokerage firms.

They've been the cause of many of the big losses at those institutions. No, firing four of your top risk analysts and piling on the risk is the cause!!!

In CDOs, risk is portioned out to different groups of investors. Those willing to take the biggest risks buy securities with the highest potential returns, while investors who want more safety give up some return to get it. Already, the riskier "tranches" of CDOs have sunk dramatically in value. An index that tracks risky subprime bonds has fallen to a record low of 17.4 cents on the dollar, down 50% from August, according to Markit Group. In other words, a billion is now only worth 174 million. I don't even think the short traders get that kind scratch on a good day.

That decline, while worrisome, hit investors willing to take risk. But the recent turmoil stems from declines in the market for the safest securities. Rated triple-A, they should be affected by mortgage defaults only in extreme circumstances. An index that tracks triple-A securities is trading at 79 cents on the dollar, down from roughly 95 cents just a month ago. Good Lord, even the rich are suffering! Help us!

At the top are "super-senior tranches." It is a decline in value of these supposedly safe securities that is hurting many banks and brokerage firms. Because banks must value many of their securities holdings at the price at which they could be sold -- called marking to market -- many banks have had to report losses. As an appraiser, when I hear the words "could be sold" I automatically think "probably won't be sold" because sellers always list their "wares" higher in order to negotiating or "wiggle" room. So if these..."things" are marked at let's say 500 million, take off five-ten percent for negotiating, that leaves you with a value of roughly of 450-475 million bucks. In today's market. What will that be like in let's 1Q08?

In October alone, Moody's Investors Service, Fitch Ratings and Standard & Poor's downgraded or put on watch for downgrade more than $100 billion in CDOs and the mortgage securities they contain. In a glimpse of how much banks have at stake, UBS holds more than $20 billion of super-senior tranches of CDOs. They're among the reasons UBS, which reported a third-quarter loss of 830 million Swiss francs ($712.8 million), has warned that its investment bank is likely to face further losses in the current quarter.

"There was some widespread miscalculation when it came to estimating the credit risk and market risk of the super-senior tranches," notes Ralph Daloiso, managing director of structured finance at Natixis, a French banking group.

Specialized funds known as structured investment vehicles, affiliated with banks and independent managers, invested in the top-rated tranches of CDOs. Banks set up the funds as a way to derive income from securities held off their balance sheets. The SIVs borrowed money from outside investors by issuing short-term and medium-term notes, then used the money to pay for the securities. Now, though, investors' reluctance to lend to SIVs has raised concerns that the funds -- which hold some $300 billion in assets -- could be forced to sell en masse.

The SIVs are the focus of an effort by major banks to raise a rescue fund that could reach up to $100 billion. The intent is to calm markets by buying good, highly rated securities from the SIVs. But the fund is still weeks away from coming into operation. And the deterioration of even the most highly rated securities will make it increasingly difficult to differentiate between good and bad investments.

The large Wall Street firms weren't alone in believing triple-A-rated debt securities were safe. In the last few years, bond insurers such as MBIA Inc. and Ambac Financial Group Inc., as well as financial guaranty units of American International Group Inc., PMI Group Inc. and ACA Capital Holdings, aggressively wrote insurance on super-senior tranches of CDOs that were backed mainly by subprime mortgages. These companies effectively agreed to bear the risk of losses on these securities.

Shares of Ambac and PMI yesterday fell 19.7% and 11%, respectively, and along with MBIA hit new 52-week lows, on growing investor worry that they may need to hold more capital against the risk they are insuring and could be hit with sizable claims down the road.

Over the past two weeks, some of the insurers posted significant net losses for the third quarter because of adjustments on credit derivatives they used to provide insurance on the bonds. The bond insurers have said, however, that they don't expect actual losses from the CDO tranches they have insured.

Anywayz, you get the gist. If you want my advice, save your money. Buying oppurtunities will abound, whether in stocks or housing in 2009. That is of course if Armageddon doesn't pop.


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