8 November 2007

Report from the belly of the beast - models/modes busted

I just finished polishing up an e-mail from a buddy of mine's son (an up-and-coming hotshot at an investment bank) who attended this week's “ABS East Show” (a conference where all the “Debt Dicers and Slicers” get together and drink, play golf and congratulate each other on being “Masters of the Universe”).

The kid described the conference as a “cross between a baseball card convention and a funeral” in that all these former big-shot, preppie, blue-blazered, mark-to-model mavens were somber, sobered, and even downright despondent—and were all trying to sell each other used ABS, MBS, and CDOs at deeply-discounted prices. He also stated that they had some kinda weird “Speed Dating” event where the shysters were matched up for ten-minute sessions to give their pitch to investors. Hmmmm…

I asked the kid to forward to me his electronic notes taken during the sessions he attended so that I could share them with the board, and he was all too happy to zip them right over—as long as I promised NOT to reveal his identity. “No problemo”, I promised.

His short-hand scribblings represent his capturing of the salient points from various panel discussions and seminars over two days.

Interestingly, as I was reading the cryptic-but-clear thoughts he shared, I was struck by:

a. How much these guys at the conference sound like we do here and:
b. That I actually understood much of what they were discussing, although some of the finer points they were discussing that I didn't understand, I edited out.

Now, for those who don't want to take time and rummage through all the statistics, comments, and prognostications below, please allow me to sum up in one, succinct, sentence the collective message of this little get-together:


For those of you who DO want to take a peek into “the belly of the beast” so to speak, here are the kid's notes--pretty much unadulterated by me, other than the highlighting:

Day One Notes:

Affordability Products: should have stopped lending in 2005; significant risk positioning, Wall Street took "super-senior" tranches, now equity being hit; de-leveraging taking place”

Mortgage debt to GDP: 67%

$350 billion in resets in next 12 months=disaster waiting to happen;

Banks have many loans on books with NO offset credit enhancement!;

Troubles with MBS that are already in place, can't re-fi them properly; FHA-Secure2" changing loans to fixed-rate; Very few loan modifications taking place because they are "uneconomic" to underwriter.

No one in audience thought that MLEC would solve CDO problem.

MLEC: Bail out for Citi; will transfer at "market price" but no one knows what "market price" really is

Quasi-bailouts of CDO holders going on through Fed discount window to keep system afloat; steepening yield curve ( Note: Ergo free money which lowers current rates at the expense of future rates which are bid up by inflationary expectations )

Question to audience: "Will we see ANY ABS/CDO based on mortgages in 2008/2009?

Audience response: NO!; "Who's going to take the warehouse risk?"

Fire sales may increase due to sellers refusing to sell because bid/ask is too wide for them; will have distressed sales when, not if, sellers break.

Audience question to panel: "How long before Wall Street recognizes losses in RMBS and when will market return to normal?"

Panel Answer: Remittance reports get worse and worse each month! After all of 2008 we will know more after all resets, recasts, refis and REOs; wouldn't give number for cumulative losses for vintage '06 but he stated that Fremont pools are at 30% to 40% default rate presently. Finally estimated 20% loss rate.

Day Two Notes:

2006 vintage is blowing up BEFORE getting to rate reset, stated we need government bailouts.

Possible "rush to exits" coming in CDOs if monolines credit rating deteriorates of other market events happen.

This environment is challenging our livelihood!; Rome is still burning but no one (Wall Street or DC) is coming to rescue!.

Final panel question to audience: ABX '08?

Audience response: NO!

"BBBs" have been wiped out; So has "BBB-";

Only certain dealers and monolines know where dead bonds are buried.

2006 vintage of mortgage originations is much worse than 2003!; 2006 trading at LIBOR plus 550; Prior to 2003 didn't see defaults in the 30% range, now common!;

Just because someone says a bond is worth 50, it may be worth 20; Market has been systematically incorrect.

Mark-to-model is leaving market;

We are only in 3rd inning in terms of markdown of assets.

Question: FAS 157?

Answer: Fas 157 will translate to tons of supply of ABS going forward.

Spreads are irrelevant; People buying "BBs" at 1500 bps

(Conclusion): If this doesn't send you on an emergency Wheaties run, then I don't know what will. These guys have scroomed the entire world's economy and they now realize it.

No comments: