patrick.net

I'd call this a spring splat:
http://www.housingtracker.net/askingprices/California/SanFrancisco-Oakland-Fremont/

Is there any surprise that people would find a way to funnel profits to the few and spread risk to the many? We have a choice, regulate the industry or pay for it with the money those of us who actually pay taxes pay. I don't really see a third way.

Mike,

Your average garden-variety mutual bond fund (Vanguard, Fidelity, etc.) is loaded with MBSs from the GSEs --check the prospectus. Yes, I know that the GSEs are only supposed to buy "conforming" loans and issue AA-tranche "safe" paper. However, as we've seen already, their track record at accurate bookkeeping and risk-assessment is something less that stellar. Not to mention, that Congress has kept on ratcheting up the "conforming loan" limits, so the distinction between AA and "scratch-'n-dent" is getting increasingly murky.

My big question is this: If the MBS market is going to directly affect 401k's should we all be moving our money into the "Fixed" and "Safe" portions of the 401k offerings? Thus avoiding any undue risk and also missing out on any unexpected profits? Assuming of course the company plan includes an option which has no exposure to MBS's...

Mike Says:

> Retail investors, except in a very few limited circumstances,
> do not invest directly in MBS or CDOs. In some cases, the
> AAA rated bonds are available to ‘qualified investors’, but
> there is no default risk associated with those.

Like Mike I’m bearish on the housing market but can’t even imagine a market so bad where the AAA MBS investors would not get repaid (even US Government Treasury investors have interest rate risk and mid term bond value changes). For an example let’s say that a MBS pool of loans has just 10 $400K loans. A pool never has all 80% loans so let’s say the LTV of the 10 loans ranges from 60%-80% with an average LTV of 70%.

Out of this 70% only about 80% will go to the AAA traunch. So even if every single loan in the pool defaults (my odds of winning the lotto are better than having a 100% default in a MBS pool) the AAA bondholders will only loose money if the value of the houses drop ~45% in value. Even if a region has a 75% drop in value and huge numbers of people default the AAA bond buyers will get paid back.

HARM, I do not directly own any MBSes. However, I do have some fidelity mutual funds in my 401(k), mostly stock. Is there any way some of these mutual funds are invested in MBSes?

That worries me. I have consciously avoided investing in the real estate market and I would be quite chagrined to know that indirectly I still am.

So the general consensus here among the professional finance types is that GSE-issued paper (considered AAA or “investment grade”) is basically about as loss-proof as a T-Bill? If so, then I guess us taxpayers have nothing to worry about, bailout-wise.

Perhaps the non finance types (including me) need a primer on what each tranche category includes, and what sorts of loans are typically inlcuded at each level:

AAA/AA?
Alt+A?
scratch-'n-dent?
toxic waste?

Sriram,

Like Person said, even if you hold zero bond funds in your portfolio, the companies whose stocks you do hold might have a substantial position in the MBS/CDO market. Not to mention that the S&P 500 or other stock indexes (Russell 2000, Wilshire 5000, etc.) are bound to include a few home builders and mortgage lenders. I guess it's pretty hard to tell without examining the books of every company, and equally hard to divest from housing 100% --the markets are just too involved in RE to avoid it completely.

I guess it’s pretty hard to tell without examining the books of every company, and equally hard to divest from housing 100% –the markets are just too involved in RE to avoid it completely.

Right. But I think for the typical retail investor, their to these toxic mortgages exposure is fairly minimal.

This is interesting:

"The robot homebuilder

By NATHAN HALVERSON
THE PRESS DEMOCRAT

Imagine a giant robot that works 24 hours a day churning out custom houses, moving from one job to another without complaint, fatigue or injury.

Behrokh Khoshnevis, a University of Southern California engineering professor, imagined just such a machine more than 10 years ago. Today, he is only months away from debuting a working prototype.

Khoshnevis, who will speak Thursday in Rohnert Park at Sonoma State University's Engineering Lecture Series, is working to develop a programmable machine that can build houses at a mere fraction of the time and cost of traditional construction.

It is no small endeavour. Khoshnevis hopes robotic automation will make it possible to build a 2,000-square-foot home in 24 hours and at one-fifth the cost of traditional construction...."

http://www1.pressdemocrat.com/apps/pbcs.dll/article?AID=/20070212/NEWS/702120370/1036/BUSINESS01&nocache=1

(How do you get the tinyurl?)

OK, found the tinyurl place.
http://tinyurl.com/3cha4q

I guess their business model is to support themselves with ads for "Rich Dad" seminars?

Mike / Person,

It was nice to know that most retail investors have exposure mostly to 'safer' MBS. (Yes, there are 2 occurrences of 'most' in that sentence.)

To add to HARM's question, who the hell is buying the subprime loaded MBS or anything that is not AAA. By Hedge funds do we mean only the wealthy folks who have the access to these ? It's not easy for a retail investor to have access to these. Are these being bought by foreign investors - (banks, mutual funds etc) - so retail investors in other countries may have bought this riskier type ?

I fall in the category - know something about the stock market, but zilch about the bond marker. There may be many like me. So any insight is helpful.

Khoshnevis hopes robotic automation will make it possible to build a 2,000-square-foot home in 24 hours and at one-fifth the cost of traditional construction

SFWoman,

That would be an amazing brealthrough, if it turns out to be practically feasible. Unfortunately, though, I doubt it would make much of an impact on the housing bubble --at least not in CA. The real speculation and asset appreciation is in the land, not labor or raw materials.

OTH, it might have a very big impact on, *ahem*, "guest workers". If prof. Khoshnevis also invents an inexpensive lettuce-picking machine, about the half the state is shit-out-of-luck.

Harm,

I thought it would wipe out one of the last remaining decent paying jobs for people without college degrees that is left.

HARM Says:

> So the general consensus here among the professional
> finance types is that GSE-issued paper (considered AAA
> or “investment grade”) is basically about as loss-proof
> as a T-Bill?

Remember T-Bill is only “loss-proof” if you hold to maturity. If you need cash and have to sell a T-Bill you bought today with a 4.80% coupon in two years when the current on the run T-Bills have coupons of 8.00% you will sell at a big discount and take a big loss.

For more on bonds read:

http://tinyurl.com/yqug2t

Ok, so it's basically like a giant prototyping machine. The main issue I see is that I don't want my house to be constructed of cinder-block type material. That robot will need to cut wood, fit floors and drywall and do other very precise tasks. That sort of automation is very difficult to achieve.

Now commercial construction I could believe. A robot an easily place and weld rebar and direct concrete forms. That gets you bridges, parking garages and all sorts of useful structures.

As others have already said, there is a very legitimate reason for the existence of MBS/CDO upper tranches. One is the difficulty in matching duration of T-Bills and Notes, as well as the yield curve on any given day.

Also, there is a very good reason why investors (which are *not* retail in any circumstance) would want 2nd or 3rd tranches. The top tranche, AAA as some called it earlier, is actually *more* risky than AA-ish. That is because of the top tranche carries a very large pre-payment risk. Every US-style conforming mortgage contains an embedded option which allows the borrower to pre-pay. As a buyer of the MBS I may not want to own a callable mortgage bond which the issuer can and very likely will call it exactly when I don't want them to -- that is when my real returns are highest. I'd rather step a tranche or 2 down so I get a much lower pre-payment risk, and can balance the rising default risk with some nifty financial alchemy.

I really shed no tears for the whole MBS/CDO saga. G'ma and G'pa aren't in the chain. They don't own anything that invests in toxic-waste tranches. The paper they own through funds is probably better than US-Treasuries in many situations. The buyers of all the toxic shit have been hedge funds, foreign investors and foreign central banks. Even that's not the problem--they can buy as much junk as they want. The problem is quite simply the risk premium has been systematically mis priced, and all these guys overpaid for their junk bonds.

But then, money is cheap globally, so the argument chases its own tail. When money only costs you a couple %, a junk bond doesn't seem so risky so long as a few pay off.

I read quite a few California History books and I just got to a chapter that explained how Claus Spreckles (the brother of the guy who built the Spreckles Mansion in Pacific Heights where Danielle Steele currently lives) knew that former San Francisco Mayor Eugene E. Schmitz was on the take just after the 1906 Earthquake. “Once elected Mayor Schmitz began building an ornate mansion at the corner of Vallejo and Pierce that cost five (5) times his salary as mayor”…

Mayor Schmitz should have just legally taken low interest loans from business partners or legally set his spouse up with lucrative government contracts. When he was a SF Supervisor Mayor Newsom lived in a $1mm home that was twenty seven (27) times his $37K as a Supervisor’s salary and he moved up to a $3mm home that cost about thirty (30) times his salary after he was elected mayor. Senator Feinstein paid $16mm for her new home in the City that is (after the rehab cost) just over one hundred (100) times what she makes as a Senator…

I-bonds don't have principal risk. Interest is compounded, kinda like a zero coupon kind of bond, I think.

They don't really have interest rate risk, either, once you've held them for a year. You can redeem them early for full face value, plus much of the interest, if a newer issue comes out with a higher base rate.

They are direct treasuries, no insurance involved. So unless Al-Queda destroys our federal system, the treasury guarantee seems safe. I think that even if that happens, the states would reconstitute a new federal system and make good on old federal obligations. There are precedents.

No, they are not glamorous, they are not sexy, right now new issues only pay 4.5 %, but overall they're a good way for Americans who are stuck in the dollar economy, to save dollars.

I asked a robot to build my house, and this is what it did :(

can you get a brick-laying machine? I would think a brick-laying machine would be useful. Bricklayers are paid a lot, and it is extremely time-consuming...

Actually, a cement rendering machine for multi-storey projects would be good also -- that feeds into one of my many get-rich-quick ideas for home makeovers. If you could erect a minimal vertical scaffolding rig that the machine could traverse in 2 dimensions and render surfaces, that would be brilliant. It would just have to work out how to go around windows and doors... That's so inspiring I might just work on it...

The buyers of all the toxic shit have been hedge funds, foreign investors and foreign central banks. Even that’s not the problem–they can buy as much junk as they want. The problem is quite simply the risk premium has been systematically mis priced, and all these guys overpaid for their junk bonds.

Gosh, Randy, when you put it like that, screwing over MBS owners sounds like... poetic justice.

PuffDippy,

Well, you beat me to the punch. Bring down the thunder sir!

With some HF's having minimums as little as 5K (and their largely unwarranted popularity) it will hit a segement of the population that can least afford the hit.

Right now we're getting an e-mail a day reassuring us as per Mike's post above. The truth is, it won't matter. Wall St. runs on rumors, always has. This "guilt by association" will likely be dealt w/using the "shotgun method" (meaning w/ a shotgun, you're bound to hit "something"?) Right now it "appears" that the dollar flow at the retail level is moving out of MBS (int. rate sensitive, pre-payment/no payment issues) and towards income that is "buy-write" driven as witnessed by the HUGE ETF IPO's being done on a monthly basis. It's so prevalent you have to weed through all the "me too" offerings. With the yield talk flirting w/double digits why buy MBS? Period?

DinOR

In the US don't all hedge fund investors, regardless of how small the minimum fund investment requirement, have to pass as "qualified purchasers" under SEC rules? That used to mean $1m net worth, $200K salary and $5m total assets.

Not a lot of people are going to shed tears for people in that category losing their hedge fund investments. Anyway, I really doubt that many have anywhere near all their eggs in the HF basket. Most people I know with HF investments view them like people used to view emerging economy funds about 10-15 years ago: good to have a little there for the returns, but good chance you could lose it all.

Randy H,

As usual, you're right. Problem is virtually NO ONE is verifying the validty of these "sophisticated investors" credentials. In many cases it's actually administered on line.

*This site contains nudity and s_xual content:
No one under the age of 18 allowed!

I mean it's just that laughable! Let's be honest here, it's a hell of a lot easier to find 1,000 guys w/25k than ONE w/25 mil. The sheer proliferation of these things should be telling us there are some "minors" on the web-site.

Bank of America Higher Standards?

Looks like it's time to fire up the presses at HARM/X Industries!

HARM, you and X stamp out the plastic and I'll sell them as LBS (lettuce backed securities)! Do you have any idea how HUGE this is going to be?

(Never mind it's illegal) when has THAT ever stopped bangsters before!

Good Lord.

Why robots? What about factory-built homes? People often confuse them with manufactured or mobile homes, but it is possible to have modular houses built completely off-site with much better quality than conventional homes and then get them installed in weeks.

Sriram Gopalan,

AND they're NOT assembled in all kinds of weather AND vadalized etc. etc. I took the time to tour one of the mfg. home builders in the valley and it was time well spent. These people work w/the same guys day in day out and have a TQM approach. Besides they have to be built to withstand transition to their home-site. I wonder how many overpriced stucco sh@tboxes could stand up to that!

True, not as classy as Michelle Kaufman's "Glide House" but unlike traditional approaches where the electrical guy blames the painter, the painter blames the drywall guys, the drywall guys blame the framers.......

DinOR :

Are you talking about BofA'a credit card for illegal immigrants ? Hey, the market loves it, stock is up nicely.

Yesterday oil was down, so it means good for stocks - but the market was broadly -ve. Go figure.

Today, the trade gap hit a new record. Should have been bad for stocks, but everything is up. Go figure.

Watching the daily gyrations of the stock market is as pointless and entertaining at the same time, as watching some B-grade horror movie.

StuckinBA,

Agreed. I was short the Yankee Dollar and the S+P 500 during last summer but w/$70 a barrel oil and Israeli troops in Lebanon the market just laughed it off. (I made out "o.k" but it should have been HUGE!)

Throughout the 4th qtr. as "BLown-it" was imploding it wasn't a concern. Now I guess it kind of is. :(

Randy and others,

Where do "jumbo" loans figure into this MBS mess ? Since the GSEs supposedly don't buy it, where do they get funded from ? Or do the GSEs buy the conforming part and the amount above comes from non-GSE sources ?

Almost every loan in BA is a jumbo loan. It may be comparable to AAA rated, and the investor appetite for them may remain unchanged. Any insight on how this may play out ?

StuckinBA,

Well know that IS a good question! There was a time when "jumbo" loans were only given to the best of customers. Another thing I'd like to know is if most MB's that wrote themselves jumbo loans charged themselves points (huge pay-out) or took the discount?

OT:

Michelle Malkin had an uproarious take on the Illegal Alien BofA Gold Card!

Typically, a hedge fund needs to have at least $25 million in assets to generate sufficient fees to sustain itself. For regulatory and practical reasons, you'll never reach $25 million by relying on a thousand people investing $25,000. You need investors who can write checks of at least $250,000 -- and, in reality, much higher amounts. This effectively screens out the average Joe regardless of how sophisticated he claims to be. Also, keep in mind that the $250,000 number is a practical minimum for a small hedge fund, and the small funds are not your typical players in the MBS/CDO market. The larger hedge funds typically will not consider you as an investor unless you can write at least a $1 million check. You can lie about your credentials, but if you don't have the cash to back it up, you'll never be able to invest.

Shanghai real estate goes bust.

http://www.lestwarog.com/newsArticle-2010.html

sorry - just noticed that it is an old article - march 2006

Sandibe,

Any decent boiler room worth it's salt w/50 or so brokers can raise that in under a month ( I should know). Done it on several occasions. You ARE right though, w/lower min. the expenses WILL be through the roof (but do you want a HF manager or don't you!) We can always tout a non-AIMR compliant return and leverage our "track record" down the road w/bigger fish.

One HF states clearly in their "red herring" that their min. NW for clients is 150K OR! a NW of 45K IF you have an income of 45K! (So basically everybody). Minimum investment of 5K (and subsequent inv. a min. of 1K).

I'm not saying they're aren't guys that belong in HF's (or the HF biz) but it's gotten out of hand. WAY out of hand.

DinOR, HARM/X Industries is please to announce a 5 billion dollar issue of LBS payable to said principles. For brokering (floating the paper downstream?) we are please to offer you as much as 90% of the face value provided the co-founders of HARM/X Industries LLC, GmbH, OTSY* are denominated to the tune of 5% of face value. Note, each LBS is denominated with black marker pin by LBS professionals working in King City.

*Out to screw you.

crap

-pin
+pen

DinOR,

Any hedge fund that uses the boiler room tactic you describe is running afoul of a number of federal securities laws. If the investors in those funds lose their shirts, it's not because of their exposure to MBS/CDOs. Its because they are handling their money over to a scam. I would hesitate to call the funds you describe hedge funds at all.

My point is that it is very difficult for the average Joe to invest in a legitimate hedge fund because of the barriers to entry. Most hedge funds rely on one of two exemptions to avoid regulation as a mutual fund. Under the first exemption, all investors need to be "qualified purchasers" which, in the case of an individual, is someone with at least $5 million in investments (that's investments and not just net worth). Funds relying on this exemption have more important fish to fry than the average Joe (or even the above average Joe). The second exemption is available only if the fund has 100 or fewer investors. If you have to target small fry, you have no choice but to rely on this exemption. But it is hard to see how you can legally raise a meaningful amount of money if you only have 100 investors putting in a few thousand each.

Sandibe,

Well I was actually covering a few issues at the same time w/ a broad swath but there is absolutely nothing illegal about soliciting securities transactions over the phone and legit firms do it everyday, I assure you.

Right now Christian Baha is taking investors down to 5K. I know, I know that's not a "real" HF. SFWoman's husband is innundated w/guys basically off the street wanting to start HF's under whichever exemption they can shoe horn themselves into but he isn't taking on any new clients. I imagine for a reason.

I'm not an expert in securities litigation (and I don't want to be) but it was that aura of "no guarantees here" that opened the door to a largely unregulated, unaudited and unmitigated disaster. For each HF that opens, one just went bust. In the meantime the "managers" carved out a nice living for themselves. Why are you defending these guys?