September 29, 2008
charles hugh smithA veritable hurricane of "happy talk" has swept through the Mainstream Media as everyone from President Bush to "gummit bailout and bond king" Bill Gross is talking up the expectation that not only will the bailout eventually cost taxpayers nothing--it will turn a big profit!
All sorts of fantastic claims are being giddily bandied about by "experts" such as Mr. Gross (ahem, isn't it these self-styled "experts" who apparently saw no risk in a decade-long credit bubble until two weeks ago?) that taxpayers can purchase distressed assets at somewhere between "mark to maturity" (i.e. the full value of the mortgage if it was paid off in the future) and "mark to market," (i.e. a horrible, terrible ghastly "fire sale" price which an investor might offer at open auction).
Commentators such as John Mauldin are basically whining that bundled mortgage bonds (mortgage-backed securities) are selling for far less than their "real value":
Last week, I wrote about a formerly AAA-rated residential mortgage-backed security (RMBS) composed of Alt-A loans, better than subprime but less than prime. About 5% of the loans were delinquent, and there are no high-risk option ARMs in the security. It is offered at 70 cents on the dollar. If you bought that security, you would be making well over 12% on your money, and 76% of the loans in the portfolio of that security would have to default and lose over 50% of their value before you would risk even one penny. Yet the bank which is being forced to sell that loan has had to write down its value. As I wrote then, that is pricing in financial Armageddon.
The bank is offering the bond at $.70 because it knows there is quality in the security. They are being forced to sell. And guess what? There are no buyers. An almost slam-dunk 12% total-return security with loss-coverage provisions that suggest 40% of the loans could default and lose 50% before your interest rate yields even suffered, let alone risk to your principal – and it can't find a buyer.
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