Posted on 08/10/2007 5:26:48 AM PDT by Moonman62
Good advice.
Well obviously they should change the model they mark to then . . . : P
Derivatives have never destablized the markets as much as people have claimed they have the power to (yet) but these modern derivatives are very hard to control or regulate. The SEC attorneys take forever to figure them out enough to act. The SEC and CFTC uses investigators that are “street smart” but are not usually mathemeticians and are frankly not even in the same league academically as the fellows creating the derivatives, so it takes the regulators forever to figure out where a violation occurs and usually requires a whistle blower of some kind to explain the issue. I guess I’m saying that if the model is significantly flawed, the property related derivatives could be another layer of things that could destablilize the market further, rather than explanation of why it’s a good time to buy . . .
I’m the kind of guy that calls out that the market is falling more often than it happens . . . but . . .
No.
There should be no “mark-to-model,” period. If you want to price something, you put it out into the market.
The reason why the credit markets are blowing up is that the mark-to-model CDO’s hid the deteriorating value of sub-prime infected debt instruments from the market for far too long.
Suddenly when the funds holding the CDO’s were forced to put the CDO’s into the market, they found out just how far off their models were.
The root problem here is that the valuation model for CDO’s was created by the same banks selling the CDO’s. So if we wanted to keep mark-to-model valuations, then the models need to be created by some other bank not selling the instrument, which would remove the obvious conflict.
Your assessment of the SEC’s brains vs. the banker/fund brains is correct, which is why I believe that mark-to-model should be simply banned. Let the market do what the market is supposed to do: value assets in open outcry.
Not to mention that what has been disclosed thus far **may** be only the tip fo the iceberg.
I recall a guy buying a $400,000 home who was making about $15,000. How many cases like this are out here?
I said for years this would end badly.....only am surprised it went on as long as it did.
Yes, there are some shorting out there. They’re not evil, they’re just “tradin’ the ‘mo’” or going in the direction of momentum.
They’re getting their heads handed to them too. The big rally earlier this week was powered by short covering.
Its not just mortgages though. The whole corporate financing pool is drying up as well. So there goes the buyouts by private equity, which has been pushing the market up for quite a while now. Also limits companies growth when they can’t borrow for acquisitions or expansion. Or the cost of financing increases and all those projects cost more.
Yes, this was called the “liar loan” in the mortgage business. More formally, it was called the “stated income” loan, where the bank believed whatever you told them for ‘income.’
The whole mortgage industry needs reform, starting with Fannie and Freddie, and then down to lending regulations that out-and-out prohibit loans to people without a real credit check.
I know the regulatory side of things in more than a passing fashion, but from a lower level perspective. Nuts and bolts, when the higher ups get excited about a case they have access to the commissioners and their staffs, and lots of resources, to throw at a case. But before the excitement builds there are competent professionals, but no derivative “rocket scientists” doing the digging and putting the case together in the early stages. Lots gets missed. Meanwhile, I’ve known a former IBM researcher, Ivy League PhD in physics, who went to Wall Street to do the math for the firms regarding derivatives.
My perspective was solidified by seeing this morning that a AXA money market fund in Luxembourg is down 26% today, as a result of the fund discovering that buying CDO’s wasn’t such a hot idea.
If I were a Euro-zone investor with money in a money market fund that went down 26%, I’d be coming after someone with a fire axe. Money market funds are supposed to be for ready, short-term, easily liquidated funds. If I were invested in a speculative bond fund, and it went down 25%+, hey, that’s what I get when I invest in junk debt.
But a money market fund? No way.
Options on stocks and commodities futures are derivatives too, and those are priced in open markets. This CDO situation is nothing more than a repeat of the bad old junk bond days - people who thought they knew what they were doing with credit and interest rate swaps got burned - and burned bad. Recall that Orange County, California, was burned by 5-year notes issued by Fannie, and derivatives that assumed interest rates would keep going down. Oh, and there was leverage involved.
History is repeating itself, only in a much larger magnitude.
BTW — the whole concept of the CDO was created by the same firm that was at the heart of the junk bond scandal: Drexel. History repeats yet again.
One of the problems of the CDO modeling is that they’re using Monte Carlo simulations. Well, that’s all well and nifty, but the buy side guys observing the sell-side’s simulations aren’t asking about the underlying assumptions the sell-side guys are making then they run their Monte Carlo simulations. This, as it turns out, it resulting in customers who are very under-informed about what real risk they’re buying when they buy a CDO.
I’d be more sanguine about leverage combined with mark-to-model if the SEC would impose real penalties on those firms that deliberately abuse the system. By all rights, Drexel should have been put out of business permanently, everyone in the firm should have lost their licenses, the executives all should have gone to prison for a nice, long time. The penalties should have been so severe that every other firm on the street would say “Whoa... let’s not do that.”
Either way, one or the other of the issues has to go: either mark-to-model, or leverage on mark-to-model assets. Removing either one would remove debt market blow-ups like this one, or the junk bond blow-ups of the 80’s.
Excellent summary Dave.
My perspective was solidified by seeing this morning that a AXA money market fund in Luxembourg is down 26% today, as a result of the fund discovering that buying CDO’s wasn’t such a hot idea.
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Wow. If AXA is structured there like it is in the USA then a whole bunch of financial planners just took the clients that were looking for the safest types of investments, and paying a financial planner to direct them to the safe investments, and threw them in a shark tank. Hope not many American clients were directed to invest in the fund. Ugly.
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Either way, one or the other of the issues has to go: either mark-to-model, or leverage on mark-to-model assets. Removing either one would remove debt market blow-ups like this one, or the junk bond blow-ups of the 80’s.
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Sounds right to me. It’s a very good, common sense way to take the risk out.
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