I think we should be told.

-The Wizard of OT-

The NAB recently wrote down the value of it’s CDO style investments in the US to zero – I think this lead to the one loss in reports of about $890 million.
This appears to be an inconvenient truth being put into the market place but how has the US banking sector avoided noticing this prominent price signal?

NAB’s exposure was predominantly to subordinated layers (i.e. “senior”, as opposed to “super senior” tranche at the top) of 10 CDO structures. In one of these CDO structures, the “super senior” tranche above NAB’s position was liquidated, thereby taking priority possession of security and crystallising losses on a mark-to-market. There was assessed to be insufficient value left for remaining subordinated tranches to make a recovery, forcing a total write-down of NAB’s subordinated tranche in that structure. On the basis of that experience, and NAB’s expectation that further liquidations were likely in its other exposures, NAB wrote down – pretty conservatively, IMO – its overall CDO exposures by 90%, to 10c in the dollar.

It didn’t go unnoticed in the US banking sector (e.g. it got a write-up in the FT), but it’s not necessarily representative of broader CDO experience. Clearly, NAB chose to “kitchen sink” its write-down to kill the issue, but that is not an option for US banks given their much greater proportional exposure to these instruments. Not only would it be suicidal, it would also be unrealistically conservative to write down these assets across the board by the same magnitude as NAB given that default rates on the assets underlying these structures are well under 90%.

The role of the two mortgage guarantee companies was made perilous by the larger number of subprime loans given out as the low interest rate environment prevailed and the risk assessment model incorrectly priced the risk inherent in these loans.

That’s easy to say in hindsight, as default rates currently being experienced are well above ex ante expectations. As often happens, the models were wrong.

This document outlines just how politicised were the commercial transactions of the GSEs under the regulatory framework administered by the US Department of Housing and Urban Development.

This document appears to have been authored in 2005. HUD is articulating onerous social goals for the GSEs in the jaws of the current housing crisis.

An example:

HUD’s 2004 Regulation imposes no requirement for the total number of home purchase mortgages that a GSE must buy. Rather, the rule provides that, however many home purchase loans in metropolitan areas the GSEs buy, a certain percentage must be in each goal category. For example, if a GSE buys one million home purchase mortgages in metropolitan areas in 2005, then 450,000 of these mortgages would need to be for low- and moderate-income families.

http://www.hud.gov/offices/hsg/gse/gse.cfm

Blogging can be a learning experience.

I agree that the problem could have been avoided .There were many crusty old style banking analysts making this point over many years( Bank of Santander for example).
The same people who were NOT acting as rainmakers for their banks in the newer style loan syndication markets and anyway ” who listens to old people anymore” is the usual bull market attitude.
The role of the two mortgage guarantee companies was made perilous by the larger number of subprime loans given out as the low interest rate environment prevailed and the risk assessment model incorrectly priced the risk inherent in these loans.

I think youse shoueld all get ovah it! Missys sexuality is hwer own businzess!

10 points for Gryffindor.

I thought that traditionally the mandate was to provide finance to conforming borrowers (ie. good credit risks). Where is the evidence that their raison d’etre is/was to fund poor credit risks (recent investment decisions most certainly don’t count)? Seriously, I’d like to see the evidence. My understanding is that this all changed fairly recently when the OFHEO gave, presumably at the GSEs’ request, the go ahead for subprime investments (cue shot of Scrooge McDuck with dollar signs in his eyes).

That’s the problem. Subprime loans WERE conforming. Because we now have a “SUBPRIME CRISIS” there appears to be a generalised attitude amongst hoi polloi that there’s is something nefariously new about subprime. There isn’t. Subprime simply means of below “prime”, “normal” or “standard” credit rating, and has been around forever. Don’t have enough money to get a decent deposit together? “Subprime”. Defaulted on a couple of credit cards 10 years ago? “Subprime”. Don’t have much income to cover debt service costs? “Subprime”.

And, yes, both FRE and FNM are required, under their charters (Fannie Mae’s is here, Freddie Mac’s is here), by the US government, to support disadvantaged [read: poor credit] segments of the economy. And, as I noted earlier, if you have a large chunk of the mortgage market and a large chunk (around 25% – definitions vary – of originations in the past couple of years) of that market is “subprime”, then you’re going to cop your share of nasties. Now, when the housing market is travelling OK, there are no major problems, and losses across diversified portfolios are low. However, when the US experiences the worst housing market since the Great Depression, well…not so much.

Look you obviously know much more than I do about all this stuff, but aren’t you getting things backward now? As far as I know, there is no legislated or otherwise mandated minimum share that they must maintain that would oblige them to buy subprime mortgages or CDOs (however few). Their share reflects their foolishness in investing in these areas. Perhaps I am missing something that would compel them to go for these instruments (other than, of course, a desire to enrich themselves and their shareholders).

“You could argue with the benefit of hindsight that they coulda and shoulda dodged the subprime and Alt-A segments, but buying these mortgages WAS and IS their job.”

I thought that traditionally the mandate was to provide finance to conforming borrowers (ie. good credit risks). Where is the evidence that their raison d’etre is/was to fund poor credit risks (recent investment decisions most certainly don’t count)? Seriously, I’d like to see the evidence. My understanding is that this all changed fairly recently when the OFHEO gave, presumably at the GSEs’ request, the go ahead for subprime investments (cue shot of Scrooge McDuck with dollar signs in his eyes).

BBB

Li Kao, how about buying a shitload of subprime mortgages and CDOs?

Neither FRE nor FNM were big investors in CDOs.

As for subprime, are you fucking kidding me? it’s hard to avoid the subprime segment when you have half of the entire mortgage market either on, or guaranteed, by your balance sheets. It’s also hard to avoid “subprime” segments (i.e. poor credit risks, like poor people) when you’re chartered by the government explicitly to support “affordable” housing precisely to this segment of the population. It’s just another of the great ways in which the US government has helped to create the sub-prime mess in the first place.

You could argue with the benefit of hindsight that they coulda and shoulda dodged the subprime and Alt-A segments, but buying these mortgages WAS and IS their job. Their exposure to subprime simply reflects their (very large) share of the underlying mortgage market. Unfortunately, their problems aren’t confined to sub-prime – the looming problem is deterioration in “prime” mortgage credit in the face of the housing downturn, which is a market-wide issue. Because the prime segment is so much larger, the downturn there is what’s likely to cause the really big losses.

I hadn’t realised you were around UQU. I’m not sure in what capacity – you might have noticed my “partner in crime” – Dirk Moses

I was friends with Dirk’s brother before uni. Dirk once went to the beach and applied zinc cream to his face. He did this in a meticulous grid pattern. When he came back his face featured lots of little red squares.
.
I saw him give a seminar on the Holocaust or something in Melb years back. Couldn’t take it seriously kept seeing the red squares.
.
I wasn’t at UQU. No I won’t tell you were my information comes from. (Sound of diabolical laughter as shadows are cast upon the wall).

BBB

Spotto fallacy of causation. F and F were privatised as far back as the late 1960s. Since then they have been profitable until 2008. The poor decisions that have undermined profitability were made by the current officers of F and F, not by the government. These poor decisions caused the problems, not any implied guarantee. There was no legal requirement for the US government to bail F and F out, until the recent legislation. That is why the legislation needed to be enacted.

Irrelevant detail that does not change the fact that their preferential position in the US financial system constituted a gross distortion, created and maintained by the US government. Moreover, you have it, typically, arse-about: FNM and FRE are not proposed to be rescued simply because they got into trouble. They are to be rescued because their size and role in the mortgage market make them “too big to fail”. Their size and role in the mortgage market are a direct result of the US Government placing them in that position.

I am curious, though, about what you think were the “poor decisions” by FNM and FRE that caused the problems. Please, do tell.

“The cashflow problems of F and F arise from borrowers in millions defaulting on repayments.”

http://www.marketwatch.com/news/story/story.aspx?guid=%7BF534B933%2DD64B%2D4CB8%2D8875%2D459D61690C2E%7D&siteid=rss

The fact that they were subsequently privatised does not alter these market distortions.

Yu Yongding doeesn’t speak

Spotto fallacy of causation. F and F were privatised as far back as the late 1960s. Since then they have been profitable until 2008. The poor decisions that have undermined profitability were made by the current officers of F and F, not by the government. These poor decisions caused the problems, not any implied guarantee. There was no legal requirement for the US government to bail F and F out, until the recent legislation. That is why the legislation needed to be enacted.

Oh, sorry, they’re only “symbolic” cos Abbott doesn’t like them and is pretending they haven’t happened.

Perspective, folks!