patrick.net

http://www.marinij.com/marin/ci_4540507

Foreclosures spike in Marin.

I would say the answer to your question is exactly in line with what I see as the real complaint against the whole MBS industry: ABUSE.

Yeah, I'll buy that. Plus, the large-scale transferal of default & bailout risk to Mr. Taxpayer c/o GSEs. I posted something like this a few threads back (can't find the exact post):

How to Make a fortune in the Sub-Prime Mortgage Business

1. Incorporate exotic mortgage shell/holding company in the Bahamas, Caymans or some other mobster-friendly locale.
2. Originate toxic Option-ARMs & I/O loans with usuriously high fees & points.
3. Sell toxic waste to clueless specuvestors, recent Carleton Sheets graduates & Casey Serin.
4. Re-package & sell off toxic waste to GSEs. Or, just repackage them yourself and sell as "low risk" private MBS/CMOs to unsuspecting hedge funds, pension funds & FCBS.
5. Wire obscene profits to various numbered Swiss bank accounts.
6. Declare BK, go out of business and disappear. Avoid regulators & burned investors with "repurchase agreements" at all costs.
7. Change identity, location and open another exotic mortgage shell/holding company under your new name.

Repeat as needed (until you are independently wealthy).

Not quite the picture that comes to mind from your typical "good neighbor" insurance commercial, is it?

"the downside risk of all the loans is correlated"

FRIFY=genius

Well perhaps not "all" of the loans but definitely enough for investors to say "It used to hurt, now I can't even hold an apple in there anymore"!

Brilliant!

Re: #4
GSEs don’t buy subprimes. They buy conforming loans.

Actually, they do. Their investors just haven't been made aware of it yet. There are more ways for crooked lenders to squeeze toxic waste into a GSE "conforming" loan than there are flies on a turd. It's all in the fine print...

HARM,
Contrary to popular belief (which was what I had thought also), there was there was not a taxpayer bailout of LTCM. Admittedly, it was the Fed who organized the bailout, but it was all private money. I suppose it could have really gotten ugly if they ran through all the bailout money and then the taxpayer would have had to pony up. At any rate, LTCM doe not leave me with good feelings for HFs.
"It was saved only by the Federal Reserve Bank of New York sponsoring a bailout of LTCM by its creditor banks. The Fed justified its intervention on the basis of the potential of the failure of LTCM precipitating a financial crisis and the creditor banks were enticed into extending credit to LTCM because their financial losses in a general financial crisis could well be more than what they stood to lose if LTCM defaulted on its loans. As it happened LTCM survived long enough to pay off its indebtedness but by early 2000 it was liquidated."
http://www.sjsu.edu/faculty/watkins/ltcm.htm

I also tend to be a bit conspiratorial and agree with you that the last step in "risk management" is usually "foist upon an unsuspecting public."

FRIFY=genius

Not genius - basic portfolio theory. LTCM and the recent Gas Futures debaucle from that other hedge fund show that plenty of smart folk think they've diversified away risk. Too often, they haven't. Bundling 10,000 assets that are all tied to the same pair of dice looks fine until snake eyes comes up and your principle is halved.

My greatest fear about buying a house in the Bay Area is that as soon as I sign the papers, 50-70% of my net worth will be tied to a single instance of a single asset class (even with 0% down). To add further insult, my position would be highly leveraged. In the current market, that still looks like financial hari-kari.

If there is a bailout, it should be a systematic one. First they should take all the mortgage brokers that sold these things, turn them upside down and shake em…..and if they don’t get enough from them, they should turn to the appraisers, then to the Realtwhores and so on until the bailout is complete.

Don't forget that (not so) indirectly, a lot of the extra dough generated by this house of smoke and mirrors was/is siphoned off in the form of bonuses for all these hedge fund, mutual fund, Fannie and Freddie managers. Too bad that money's down the drain. Probably spent on some overpriced "loft" in Tribeca or some "estate" in Greenwich.

H.Z.,

We won't really know how much toxic waste exists hidden among all the GSE "AAA-rated" paper until the SHTF, will we? Delinquency rate = lagging indicator.

Are you really expecting due diligence from an outfit so crooked it hasn't released its books in over two years (though amazingly manages to keep its listing on the NYSE) and whose CEO resigned over accounting "irregularities" that would send the less politically-well connected to prison?

The delinquency rate on MBS --just like the mortgages on which they're based-- always hit their lowest level right at a market's peak. Just like we saw headlines last year touting "lowest delinquency/foreclosure rates in decades", same goes for Fannie & Freddie. Mortgage delinquencies & foreclosures are now creeping up, soon to be followed by MBS & hedge fund blowups. Who/where/how bad are the only unknowns (IMO).

The LTCM issue is ironic. My understanding is that the Fed's bailout plan in part has enabled this "hedge fund bubble" we are seeing today.

OT, but could it be that the conspiracy theorists are right after all, and oil/gas prices WILL rise after the midterm elections? I know, I know, prices are determined by complex factors, etc etc., but the timing of this below:

http://biz.yahoo.com/ap/061024/oil_prices.html?.v=11

is uncanny.

@H.Z.,

Point taken. I agree that private, subprime MBS will get hammered worse that the GSEs (at least in terms of the % of loans that go bad), but here's the rub: the GSEs are orders of magnitude larger than any piddling private MBS outfit. Even if a small % of their loans turn out to be camouflaged turds, the economic and political repercussions could be enormous.

It's true (some of) their chicanery was exposed before the absolute market peak, but not before a lot of damage was done. I wouldn't assume they're completely "safe" until this mess fully unwinds, years from now.

Add to that the currency manipulators like China, India, Korea, less so Japan, and you have long-run disequilibrium demand for USD-denominations.

Are they, though. They were low wage countries before globalisation and large-scale international flows of capital, and they are low wage countries during globalisation -- in fact, that's probably the major reason globalisation kicked off. That there are many people in the world on very low incomes compared to the West is not manipulation, nor is it news.

Insurance companies use Reinsurers, like Swissre. The scheme is almost exactly like the MBS scheme. I doubt most people who sign up with Progressive or the little lizard guy or whatever know that their specific risk (like being a terrible driver in excess of what the “risk adjusted rates” should reflect) is effectively funded by large institutional and foreign buyers of that risk.

Yes, I wonder how the $7bn bill for the WTC towers collapse echoed around the world -- they were mostly insured with European insurers who in turn would have been reinsured, possibly back in the US.

Skibum began the thread with a comment regarding MBS threat to mutual funds. At the risk of asking a dumb question, how does one investigate this with regard to one's portfolio?

For example, does Vanguard's Total stock market fund (VTSMX) have MBS risk? (https://flagship.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0085&FundIntExt=INT)

Are index funds less likely to have MBS risk than managed funds?

I'm learning a lot from this thread...thanks to all.

For example, does Vanguard’s Total stock market fund (VTSMX) have MBS risk? (https://flagship.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0085&FundIntExt=INT)

A stock fund --by definition-- would have zero MBS exposure. Bond funds OTH, may have considerable exposure. Vanguard Total bond market index fund has exposure to both GSE issued & private MBS paper, as I recall. Best to refer to your fund's prospectus.

Are index funds less likely to have MBS risk than managed funds?

Frankly, I don't think there's any correlation one way or the other. I'd thoroughly review the prospectus regardless.

HARM,

Thanks...you're right, the Vanguard Total Bond Fund has the following holdings:

Asset-Backed 1.5%
Commercial Mortgage-Backed 4.3%
Finance 8.5%
Foreign 3.0%
Government Mortgage-Backed 35.3%
Industrial 9.1%
Other 0.1%
Treasury/Agency 36.3%
Utilities 1.9%
Total 100.0%

What I find interesting is that under the "risks" section, this is the only comment I could find with respect to MBS:

"The Total Bond Market Index Fund is subject to call risk, which is
the chance that during periods of falling interest rates, issuers of
callable bonds may call (repay) securities with higher coupons or
interest rates before their maturity dates. The Fund would then lose
potential price appreciation and would be forced to reinvest the
unanticipated proceeds at lower interest rates, resulting in a
decline in the Fund’s income. For mortgage-backed securities,
this risk is known as prepayment risk."

It seems like this is the opposite of what we are discussing here, and I guess I find it surprising that there is no mention of default risk. Thoughts/comments?

Here's a very interesting report done on ABX by Nomura.

http://tinyurl.com/yjv8s9

It is quite shocking to me that MASTR (one of the 20 constituent deals) backed by UBS has the highest concentration in the West with over 73% and also the highest concentration of IO with, read this, 100%.

LTCM has become popularly misunderstood. I sometimes think it's ripe for Oliver Stone to redefine for us as most people believe things about it that aren't true.

Good point about Amaranth. The real proof is that monster crashed and yet hardly registered anywhere but in the NG futures markets. And, there were quite a few traders on the other side of Amaranth's superstar who made their yearly return off of his ego. It's also a liquidity thing. The irony is that Amaranth's trades were the right ones, and would have made a lot of money, except that they became the market, which isn't hard for big HFs to do in some of the futures markets.

And Marin Capital went down losing the better part of $2b a little over a year ago. Most people have never even heard of them, even though their failure was in GM stock & convertible bonds.

"Taking the specific case of foreign currency manipulators — China being the biggest offender"

@Randy,

LOL, sure we try to inflate away our debt to them and call THEM the offenders for trying to keep the game fair. But that's off topic. Here's an insightful piece on the derivatives market - http://www.lewrockwell.com/north/north456.html

The irony is that Amaranth’s trades were the right ones, and would have made a lot of money, except that they became the market, which isn’t hard for big HFs to do in some of the futures markets.

The only right trades are those who make money. There is no would-have, should-have, or could-have.

The real proof is that monster crashed and yet hardly registered anywhere but in the NG futures markets.

How much leverage can you have in the regulated futures markets? I guess not enough to cause cascading failure.

Randy H said:
“Taking the specific case of foreign currency manipulators — China being the biggest offender"

frank replied:
LOL, sure we try to inflate away our debt to them and call THEM the offenders

For the specific case of foreign currency manipulation, I don't see anything inaccurate about what Randy said. He took great pains to point out that forex manipulation was the specific issue. The fact that the US can (and does) inflate its way out of debt is another matter.

SP

Boston Transplant,

One of the basic premises at Vangard is that it's very difficult to outperform an index b/c an index frankly has no overheads. O.K, I guess I can go along with that but over 2/3 is in gov't paper. I'll be honest I don't like gov't paper, never have. Doesn't it strike anyone else as a little strange to why these types of funds are so prevelant in qualified plans?

Wouldn't participants be better off (long term) with more exposure to corp/pfd's? Convertibles? Anything but this pulp?

"The only right trades are those who make money"

God love you sir!

It seems like the level of understanding here regarding MBS is as good as anyone that trades them for a living. The bond desks at most firms are no longer pushing this paper. It's tough to retail and w/all the neg. MSM coverage surrounding RE who needs the headache? It's not my job to create a script to move that inventory, it's done.

Who solved the Poincare Conjecture?

Who cares. Who invented Chicken a la King?

Who invented Chicken a la King?

Yes, that person should be shot.

Yes, that person should be shot.

Why?

I do make Chicken a la King from time to time. It is not that bad.

I've always associated it with bad 1950's-style heavy-creamy vat-like foods. BTW, I prefer epicurious.com for recipe and food facts info. It's more commercial, but the recipes are generally good. Maybe I should head over to the food blog sometime...

I’ve always associated it with bad 1950’s-style heavy-creamy vat-like foods.

I do not usually use a lot of cream. You can even use low-fat milk. I like it more watery than usual. And I use ONLY dark meat.

Somehow breast meat is usually dry no matter how you cook it.

Maybe I should head over to the food blog sometime…

Do come over! greencrabs.blogspot.com

Chicken skin is the best part! :)

I think the popularity of MBS will only go down from here.

How about Labor-Backed Security? The loan can be backed by a guarantee of service or labor over a period of time. :)

How about Labor-Backed Security? The loan can be backed by a guarantee of service or labor over a period of time.

Why not just reinstitute debtors' prison?

They invest for the risk-adjusted returns.

Really? :)

I think it is because most people believe they are above-average stock pickers.

How many people even know what risk-adjusted returns are? They look at all the success stories and they want to be one of them. When they fail, they cry in front of their mothers, or worse yet, government.

Why not just reinstitute debtors’ prison?

You mean debtor's labor camps? :)

OK. Then they “should” invest for risk-adjusted returns. Now if someone could figure out how to quantify risk. Don’t tell me volatility is risk.

Risk is the conceptual possibility of an adverse outcome.

You can perfectly quantify risk only if you can perfectly predict the future. But if you can perfectly predict the future, there is no risk.

Therefore risk does not exist.

Not investment advice

Apparently according to one interpretation of Quantum Mechanics, we don’t really exist either.

Cogito, ergo sum.

BTW, what is the cheapest legal way to shop for canned ox-tail soup and Bovril beef tea?

UK internet stores usually charge $40+ for shipping.

Cogito, ergo sum.

BTW, the phrase means "I think, therefore I eat". :)

Doesn't it say it all:

"history has not dealt kindly with the aftermath of protracted periods of low risk premiums"

Remarks by Chairman Alan Greenspan
Reflections on central banking
At a symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming
August 26, 2005

http://www.federalreserve.gov/boarddocs/speeches/2005/20050826/default.htm

You'd be real surprised at how many funds that are apparently set up for the sole purpose of betting ON the US demise are investing in MBS and GSEs.

I just found out from my prospectus that Pimco's UNhedged foreign bond fund invests about 10% of its portfolio in GSE and MBS, denominated in USD.

Excuse me, the whole point of me investing in the fund is because I am betting on the USD going DOWN, so what good does it do to me for them to shuffle my money right back into USD, not into treasury, but into the stinky GSE bonds?

So read your propsectus carefully, I guess the fund managers are just running out of ideas.

I'll have to agree w/H.Z when it comes to distancing yourself from MBS. It's nearly impossible. Just a few years ago "green investors" had extreme difficulty washing their hands of things like Phillip Morris etc. I don't suppose any of us can participate in our company 401K or take positions in our brokerage accounts and have the expectation that we're "in the clear"!

Perhaps there's a marketing angle for a new Patrick.net offering above and beyond T-shirts and coffee mugs? Invest in our certified MBS FREE Mutual Fund!