Financial Re-Engineering is back and back in a big way. With credit spreads narrowing and a much more relaxed credit environment, Wall Street has started the securitization machine once again. The banks seem to have found a way to get rid of some of their bad debt. Just package them up with good debt, and have the entire tranche rated AAA.
Earlier this spring, both Morgan Stanley and Bank Of America did huge CRE/CMBS deals. But in recent months investment banks have been repackaging old crappy mortgage securities and offering to sell them as brand new securities with AAA ratings. This is identical to the complicated schemes that got them in trouble in the first place.
Its unbelievable the amount of this garbage that is still in the system. Hasn't the government back stopped trillions in losses? Have they not bought back a lot of the junk already? Are not tax payers on the hook for future losses because of this jink ? What happened to PPIP?
To think that Wall Street has to resort to the same ludicrous behavior that brought the market to a halt is really stunning. I can understand securitization is a needful business, and the financial credit system needs a strong packaging environment, but why cant we start with good debt? Why are we back to making crap look like gold? Who in the world is actually rating this junk AAA?
Most traders and bankers are stating that they need to off load these bad mortgages, so they can clear the books and start making new loans again. But were they not making loans before? The banks have been making the case that they have been lending from the beginning, that they are the not the problem, that the credit system was broken. True the credit system was broken, the banks broke it, and know they are about to break it again before its actually completely healed.
Most of the debt being repackaged is from the housing bubble, when home prices were soaring, banks and investors underwrote and bought these risky mortgages, bundled them with solid mortgages and sold them all as AAA rated bonds. With investors eager to buy these bonds, lenders came up with increasingly risky mortgages, like ARMS, Option ARMS, etc, sometimes for people who could not afford them. It didn't really matter in the end, the bonds would all get AAA ratings.
When the housing market got smoked, the market tanked, figuring out how much those bonds were really worth became nearly impossible.The secondary market for non agency mortgages just froze.
The banks and insurance companies that owned them knew there were still some good mortgages within the garbage, so they didn't want to sell everything at fire sale prices. But buyers knew there were many worthless loans inherent in them as well so they didn't want to pay full price for the remnants of a real estate bubble.
This problem has come full circle. A lot of the non agency garbage mortgages were so badly beaten up, they were never properly market down. The banks waited till the government reflated the system, some of those mortgages(Good Tranches) are now trading some 40% higher. But there is still bad mortgage debt that is still packaged out there. The market only wants AAA rated paper. Anything below that and investor appetite grows weary. So what is happening is they are taking lots of real AAA mortgages and packaging them up with AA & A Mortgages where the credit quality is not great, and repackaging them all up, then marketing them as AAA.
The real junk, the real crap goes for pennies on the dollar to hedge funds via the PPIP. This is why Geithner's PPIP has not gotten off the ground.
Give the institutions some credit here. These are structured differently. Investors who buy into the really risky pool agree to also take some of the risk away from those who buy into the safer pool. The safe investors get paid first. The risk taking investors lose money first. But it befuddles me that rating the entire tranche or class AAA. Its criminal! The only way they can sell and market these are if they are rated AAA, as pension and insurance funds can only buy them at that rating.
All this is taking a bond that doesn't necessarily have a natural buyer and creating two bonds that might have a natural buyer for each.
100% mathematical voodoo financial engineering. I am thinking they probably used the same models that caved in the market the first time here as well.
The reason this is all happening is that housing sentiment has gotten better. Its still bad, but less bad. Investors are feeling a little better about housing so this type of trading is back in vogue.
The risk here of course is, if the housing market slips even more, doesn't rebound or stops stabilizing, even these so called AAA rated investments may not prove safe in the end.
Even more puzzling, these deals are getting done because the ratings agencies have started to rate AAA again. These are the same culprits that miss read the risk in housing the first time around. Why are we so convinced they are correct now?
I personally think all of these mortgages are miss priced once again. Investors are getting the shaft. There are fundamentally miss diagnosing 4 months of less bad data and getting back in because of it. These mortgage bonds can totally decouple and become combustible very quickly if housing, employment and the overall economy get weaker, which will happen.
The only thing that is good is in the short run, there is some life in the mortgage market. They are moving bad debt masquerading it around as good debt off balance sheets. But why would banks consider wholesale lending when credit and employment conditions are getting worse?
Whats really dangerous is this is the first steps towards re packaging even more toxic debt. There is still billions in CDO and CDL inventory out there. CDO's are already complicated investments that not too many people understand. Repackaging them makes it harder to figure out what the investment is worth. The more obscure/complex the concept the more need for creative financial engineering.
We just felt the pain of the last credit/housing/mortgage bubble. That pain is still there. They have just re engineered another credit bubble to coincide with the last bubble.
Bubbles are everywhere in the world. China has both a real estate and a US Treasury bubble.
South East Asia has a current account surplus bubble. There is excess liquidity everywhere in Europe and US.
Where do you hide?
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