March 12, 2008
Distress and disagreement in the mortgage market
I was talking recently to the head of alternative assets at a financial institution and he told me about its recent experience of bidding for a $1bn portfolio of US mortgages that a bank wanted to shed by its financial year-end.
The portfolio comprised about 500 5,000 mortgages that were spread across the US and ranged from sub-prime to AAA quality - it was a real mixed bag. The bank was offering to sell the portfolio at a significant discount to face value to get it off its balance sheet - more than 20 per cent.
The investment fund went back to basics to analyse the cash flows and asset values of all the individual mortgages. It was pessimistic about the future of house prices in the US, believing that they are still some way from the bottom.
In the end, it concluded that it would be prepared to bid as much as the bank wanted for precisely $30m worth of the $1bn portfolio. The two sides were so far apart in their view of what the mortgages were worth that no deal was remotely possible.
This is the background to the US Federal Reserve’s intervention yesterday to allow banks and brokers to swap triple-A rates mortgage securities for $200bn of US Treasury bonds. Mortgage valuations are so depressed and uncertain that the related securities market is in severe distress.
I can see the argument that the Fed ought not to interfere and allow the market to find a clearing level. But there is no clearing level at the moment and, as a result, those holding triple-A paper, such as Carlyle Capital, are badly stuck.
We can only hope that this moves things along, although prices are clearly going to have to drop further before the underlying problems are eased.
The mortgage markets are entering the second part of their “double bottoming.” The historical and irrational lending practices are now finally being dealt with via the Fed and other central banking actions. Their intervention to “normalize” the financial markets yesterday will not be the last, but it does represent the start of a significant response. The Fed’s actions mark the beginning of this “double bottoming” – not the end. It’ll take another 4 to 7 months before we potentially see sustainable improvements in both financial terms and in sentiment.
The events you described are clearly part of the unwinding actions that must take place to move portfolio holders and buyers from the extremes to a common settlement. The market wants good news so it is always reacting to “silver bullets” and then pulling back when these actions are recognized as only a single lever for the total solution. Stay tuned, the show is not over yet.
Mark Dangelo
Posted by: Mark Dangelo | March 12th, 2008 at 7:12 pm | Report this commentManaging Principal
Innovative Relevance
A wiser person than I said,”Experience is what you get when you don’t get what you want”. Bankers and brokers and hedge funds are gaining invaluable experience. I hung out my first shingle as a manager of other peoples money on October 1,1987. As they say timing is everything. Equity markets collapsed and life was chock full of ‘experience’. I managed to learn a few lessons as a starving entrepreneur, namely that liquidity is always there when you don’t need it and seldom there when you do (paraphrasing fellow old bald guy Mike Milken) and the correlary, markets are made when a buyer and seller agree upon a price. In a market downdraft liquidity is mythical and sellers adjust to new realities. Experience! And how about this old saw for the boys at CCC-”leverage kills”. More experience! They say the smart guys learn from other’s experience. When do the smart guys take over?
Posted by: gym-bob | March 12th, 2008 at 8:43 pm | Report this commentSpot on Gymbo, I will try to remember it next time.
Posted by: Tom | March 13th, 2008 at 2:00 am | Report this commentA $1 billion portfolio of super-jumbo mortgages, with an average size of $2 million apiece, and only 15 or so of the 500 mortgages are worth more than 80% of face value??? Obvs I only know what you’ve written. Were they all for second homes, or something like that? But default rates on seven-figure mortgages have remained very low up until now.
Posted by: Felix | March 13th, 2008 at 11:11 pm | Report this commentFelix is right that this does not make sense. I mistyped and was out by a factor of 10. I meant 5,000 mortgages with an average face value of $200,000. Apologies.
Posted by: John Gapper | March 14th, 2008 at 2:16 am | Report this commentan easy mistake to make, for a new yorker. Any investment where the worst-case scenario is that you spend $1 billion and end up owning 5000 homes is a great one to anybody in this city.
Posted by: Felix | March 14th, 2008 at 5:46 pm | Report this comment