June 22, 2007

Merrill Lynch supposedly to hold onto $850 million subprime cancer CDOs taken from Bear Stearns' blown up mortgage hedge fund

Man, I love a good hedge fund blow-up. But I especially love one that "experts" didn't see coming, while HP'ers know damn well many more like it are on the way.


Interesting thing about this whole Bear Stearn / Merrill Lynch mess is that Merrill was gonna dump the cancer as fast as they could, but then all of a sudden they put the word out that they weren't gonna do that. Now why do you think that is?

1) No buyers?

2) Unattractive firesale prices?

3) Middle of the night calls from Bernanke and Paulson (and Cheney and Bush)?

4) Would blow up the entire industry, including Merrill, even faster?

Oh, what a tangled web trillions of dollars of mortgages that aren't gonna be paid back weave. Can you say "systemic meltdown"?

Merrill won't flood market with securities

NEW YORK -- Merrill Lynch & Co. has backed away from a threat to dump about $850-million (U.S.) of securities it seized from Bear Stearns Cos. hedge funds, according to people with knowledge of its plans.

Merrill sold a small portion of the collateralized debt obligations through an auction, said the people, who declined to be identified because the details haven't been announced. It plans to hold on to the remaining securities for now, one person said, without being more specific.

The decision, and the scrapping of a sale Wednesday by JPMorgan Chase & Co., diminished the risk that a large amount of securities would be liquidated immediately. Merrill set the sale in motion to reclaim its loans to the two hedge funds, which had posted losses of as much as 20 per cent by betting on CDOs. The plan may have confirmed that other funds were overvaluing their holdings of similar securities, potentially causing a chain reaction of writedowns causing billions in losses.

"It's an industry issue," said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York. Mr. Hintz was chief financial officer of Lehman Brothers Holdings Inc., the largest mortgage underwriter, for three years before becoming an analyst in 2001. "How many other hedge funds are holding similar, illiquid, esoteric securities? What are their true prices? What will happen if more blow up?"

30 comments:

Anonymous said...

And from Mish today...

Bear Stearns' REO Listing - A Tip of the Iceberg This is just a quick update on the continuing saga at Bear Stearns. EMC Mortgage Corporation, a wholly owned subsidiary of Bears Stearns, seems to be swimming in REOs.

You can get the file yourself by subscribing to EMC Mortgage Corporation's Properties For Sale report or you can look at a Totaled Excel File Extract of Bear Stearns' REOs that I asked Bart at NowAndFutures to host. The choice is yours.

Bart totaled the original 178 PDF for the benefit of all of us and came to a total of $779 million. Of course that is the "book value" off all that stuff. We do not know what it is really worth on the open market or what the value supposedly was six months ago. But this is just a piece of the tip of the iceberg.

The Mark to Market Iceberg

John Succo on Minyanville is writing Bear Stearns Fund Reveals Tip of the CDO Iceberg


Earlier this year I was struggling to figure out exactly what I was missing with respect to Collateralized Debt Obligations (CDO) structuring. Specifically, I wanted to know why is the market so sanguine in the face of deteriorating collateral values in the mortgage market? One of my firm's theses has been that as the mortgage market deteriorates, investors holding CDO as an investment would realize losses and this would feed into other risky asset classes. Why aren't losses being seen when the market is so clearly deteriorating?

So I asked a large broker firm to send over its smartest math person on CDO structuring. The team that came over was headed by a very smart gentleman. He was very good at math and very straightforward. Working for a broker, I was prepared for some sugar coating. I didn't get any.

The answer is simple and scary: conflict of interest.

He explained that due to the many layers of today's complicated credit products, the assumptions used to dictate the pricing and outcome of CDO are extremely subjective. The process is so subjective, in fact, that in order to make the market work, an "impartial" pricing mechanism must exist that the entire market can rely upon. Enter the credit agencies. They use their models, which are not sensitive to current or expected economic activity, but are based almost entirely on past and current default rates and cash flow to price the risk. This, of course, raises two issues.

First, it is questionable whether "recent" experienced losses over the last few years really represent the worst of the credit market (conservative). But, even more importantly, it raises a huge conflict of interest: the credit agency's customers are the very issuers of the tranches they rate. The credit agencies, therefore, need to compete for business based in part on the ratings they are willing to give these tranches. As a result, they will only downgrade when forced to by experienced losses; not by rising default rates, not a worsening economy, but only actual, experienced losses. Even more disturbing, they will be most reluctant to downgrade the riskiest tranches (the equity tranches), since those continue to be owned by the issuers even after the deal is sold.

So even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized, simply because the rating agencies have not changed their ratings for all of the above reasons. Accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.

I asked them what would force the rating agencies to change their ratings. The response was, "it's just a matter of time. If the market continues to deteriorate, the agencies at some point will be forced by the cumulative losses to acquiesce." Because these losses have been compressed, any re-adjusting of ratings by these agencies is likely to result in a massive repricing of risk. We may be there now.

Three Words: Mark to Market

Kevin Depew was also talking about Mark to Market in Thursday's Five Things.
Three Words: Mark to Market
Read them. Learn them. Know them.

CDO's are so illiquid - meaning they trade so infrequently - there is no market to mark them to.
OK, then how are they valued?
With models that the major credit agencies use based on past and current default rates and cash flow.
Wait a minute, if the models are based on past and current defaults, what happens if there is a sudden surge in defaults... like we are experiencing right now?
Nothing.
And doesn't this raise conflict of interest questions between the credit agencies and their customers?
Yes.
In fact, this is an issue Minyanville Professor John Succo wrote about more than a month ago and again today.
The bottom line is that even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized because accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.
The bottom line is that even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized because accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.
There is much more to kevin's post including charts of BBB rated tranches. Thanks John and Bart and Kevin. I'm happy to pass on what people need to know.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Posted by Michael Shedlock at 11:02 PM Bear Stearns' REO Listing - A Tip of the Iceberg

Anonymous said...

This is laughable!!
You just know there were some
VERRRY High level phone calls made in the middle of the night to stem this tide.
The question is--How will Bush and Co. stop the coming Tsunami?? Answer--Run for the Hillllls.....as fast as you can.

SPECTRE of Deflation said...

Next week is FED week. They don't control the long end of the curve, and more interest is being demanded by investors. The FED simply has no good choices, as they can lower, ain't gonna happen, to help housing/economy, or they may be FORCED to raise by the market including Foreign Central Banks.

We compete with the world for money and credit to finance our boondoggle. Everyone else is raising rates, so the FED's hands are pretty well tied on lowering.

This is a long way of saying I'm out of the equity markets, and I'm into SAFE positions.

Pigs get fat, and hogs get slaughtered. This is all just my very humble opinion, and everyone has to do their own due diligence concerning their investments.

Folks, don't pick up nickels in front of a steam roller.

Roccman said...

And the catagion continues to spread...

http://www.bloomberg.com/apps/news?pid=20601103&sid=aqDxqVCsCRbs&refer=news

"Citigroup, the world's biggest financial-services firm, lost 16 cents to $53.50 in Frankfurt. JPMorgan, the third- biggest U.S. bank, retreated 10 cents to $49.74. AIG, the largest insurer, slipped 9 cents to $71.96.

`Tipping Point'

``The demise of two Bear Stearns managed leveraged mortgage funds could be the tipping point of a broader fallout from subprime mortgage credit deterioration,'' New York-based analysts at Bank of America Corp. including Robert Lacoursiere wrote in a report published today. They added that the situation could lead to higher rates for new mortgage borrowers.

U.S. 10-year Treasury notes today headed for their seventh weekly decline, the longest losing streak in three years. Yields, which influence interest rates on mortgages and corporate loans, were little changed at 5.19 percent today. "

SPECTRE of Deflation said...

On the technical side, the INDU, SPX, RUT all look like shit with double tops and negative divergences on damn near all the indicators. WTIC is outperforming everything on the planet right now.

Think of your investments in absolute terms. Interest income beats the Hell out of a huge loss in the markets. There truly is a time to hold em' and a time to fold em'. Thank you Kenny Rogers.

Again, just one person's opinion.

Garth said...

They will negotiate a swap with either the Treasury or Fannie for better quality, albeit lower yielding, securities.

Anonymous said...

I wonder why the Bush family owns large plots of land outside the USA...hmmm....I wonder who called to stem the tide? "Don't do this yet we haven't finished the security wall at the ranch yet!!"

I am sure the RA trolls will roll through here and say that those funds are worth their whole value next.

Anonymous said...

Anonymous said...
I wonder why the Bush family owns large plots of land outside the USA...


Gee I dunno because they diversify? Cuz they don't wear tinfoil hats and think gold will be $100,000 an ounce? Cuz they do what all wealthy families do?

And what the hell is an RA troll? Some kind of sun god troll?

borkafatty said...

Anonymous said...
I wonder why the Bush family owns large plots of land outside the USA...


Gee I dunno because they diversify? Cuz they don't wear tinfoil hats and think gold will be $100,000 an ounce? Cuz they do what all wealthy families do?

And what the hell is an RA troll? Some kind of sun god troll?



---------------
Gee I dunno because they diversify?:

Diversify you say, STFU! Diversify more like steal on the backs of working tax payers.

Cuz they do what all wealthy families do?:

What they video tape themselves having sex, and then put it on the Internet...yup nice to be wealthy...again STFU!

SPECTRE of Deflation said...

Anonymous said...
Anonymous said...
I wonder why the Bush family owns large plots of land outside the USA...


Gee I dunno because they diversify? Cuz they don't wear tinfoil hats and think gold will be $100,000 an ounce? Cuz they do what all wealthy families do?

And what the hell is an RA troll? Some kind of sun god troll?

Not to mention the fact that the elite dunce thinks he's President of Mexico. By the way, where did you buy those magic ruby slippers?

cobra2411 said...

RE: "The Mark to Market Iceberg"

They're not going to mark to market the BS crap till they get pushed off a cliff. They know it's worthless but everyone's trying to spin off to the good... Look at the market... People are still in denial, but I smell some fear... The 10 dropped into the very low 5's and the market didn't respond... Oil inched lower for a little and the market didn't respond...

Lets let this cook for a little bit longer... Let the fear build, then panic will set in....


As for the FED. I'd hate to be Ben right now...

If they lower the rate then the foreign investors that have been feeding our economy will look elsewhere and the dollar will drop, the 10 will head for 6% and higher, liquidity will dry up, the stock market will pop and the housing downturn will shift into overdrive... The fed will start printing more money to make up for the loss of foreign money and inflation will soar.

If they raise rates it will kill investor confidence and the stock market will pop. That could scare foreign investors about the health of the US economy and their chance of being repaid and they will stop feeding us money and the 10 will head north to 6% and higher. The dollar will slip, housing will really crash.... Yada yada yada...

China's the wild card here. They feed us money and we buy their crap and it boosts their economy. They may overlook the risk in hopes they can help us ride it out. However they only have so much money and sooner or later it will run out when their inflation keeps rising... You can only run those printing presses for so long before they start to burn...

Their other option is to do nothing. Hope for the best and hold on. Remember that they're people too and it's very easy for them to be in denial. If it was you're job and you started to see how F'd you are, isn't it easier just to say "everything's going to be just fine..."

I lay high odds that they do nothing. They will site core inflation (which is a joke) as being under control and that they've reached a balance point. There's a small chance their raise rates and I would say no chance they cut them...


In the short term, we're hosed... Not as bad as people like China that need us buying their crap, but it ain't going to be pretty.

Keith's said it before, buy gold. If the dollar slips, gold will take off... There is a very good chance that the dollar will slip before this is all over. I know gold looks like crap now, but the same people that are saying gold sucks are also saying that the subprime issue is contained and that the housing downturn has bottomed...

Mark in San Diego said...

Wall Street is waking up to the fact that there is trouble in Hedge Fund paradise. . .markets today are reacting to the housing mess. . .from a local perspective, I can say that Fox6 did a big piece on mortgage fraud, and foreclosure. . .terms we used here a year ago - "straw buyers" "false appraisal", etc. are now mainstream, and people on the street are talking about it. . .capitulation in the Sacramento area is already taking place, as banks are now unloading houses at any price. . .they want them "off the books" by the end of this year. . .look out below.

Anonymous said...

This just delays the inevitable and increases the risks in all the financial markets. This is a house of cards that will fall at one point. Buy gold.

SeattleMoose said...

Hot potato.....

corvinus said...

Hey, Keith,

Looks like your "supposedly" was appropriate. Look at this:

http://tinyurl.com/3as63o

...and, it looks like Bear Stearns is bailing out the Bear Stearns High-Grade Structured Credit Fund:

http://tinyurl.com/2n2geh

No word yet on the Bear Stearns High-Grade Structured Credit Enhanced Leverage Fund.

(I just love these catchy names they use to put lipstick on the pig... "High-Grade"? "Structured Credit"? "Enhanced Leverage"?! LOL!!!!!)

Shakster said...

Yeah Anon ,they diversify,so you don't have to.Go ahead ,and hang on to that Housing .HangeronAnon.For now on ,we can get our government numbers from Anon,because thats all they know,and better yet ,they believe it no questions asked.
Anyone who sold housing or gold before the peak is just plain UNAmerican,shamefull,and well off,and smart,smug,and........I bet they all wear TinHats.Why don't you pass a law -No Tin hats ,no coming to your own conclusions,no independent research,and no smart investing.

borkafatty said...

Three lonely words before i depart:


Cash is king!

Agent #777 said...

Depends on what kind of $100,000 we are talking about, ANONYTROLL @ June 22, 2007 3:37 PM:

Will an ounce of gold ever be worth 10 million pennies?

Nope!

Will an ounce of gold ever be worth 2 million nickels?

No Way!

Will an ounce of gold ever be worth 100,000 pieces of printed paper, electronic credits, or empty promises?

Hmmmm.....

Anonymous said...

cool blog you have here, not sure if it's a parody though, sure hope so nobody can be this parnaoid

Anonymous said...

The China Syndrome?

Keith, at least give us something more cutting edge!

SPECTRE of Deflation said...

Anonymous said...
cool blog you have here, not sure if it's a parody though, sure hope so nobody can be this parnaoid

It would be oh so nice if you would tell everyone what the Hell you are talking about. See, that's how you get a dialogue started where folks have to think and respond. Have you used all your spare brain cells today?

Anonymous said...

Brookstreet to Liquidate Positions
After Margin Call From Fidelity Unit
By THOMAS GRYTA
June 22, 2007 3:48 p.m.

NEW YORK -- Broker dealer Brookstreet Securities Corp. is liquidating its portfolio of securities following a margin call from a Fidelity Investments unit.

The margin calls followed a markdown in the value of securities called collateralized mortgage obligations held by the firm, leading to a liquidity crunch, a Brookstreet trader said Thursday. Calls to Brookstreet weren't returned.

Anonymous said...

paranoid???

Turn off Fox News ("Fair & Balanced") and open your eyes.

The economic crisis that follows every single fed rate hike campaign (8 for 8) is finally here.

Anonymous said...

http://www.businessweek.com/investor/content/jun2007/pi20070622_099037.htm?chan=top+news_top+news+index_businessweek+exclusives

Payback is a bitch isn't it!!

Anonymous said...

Anonymous said...
http://www.businessweek.com/investor/content/jun2007/pi20070622_099037.htm?chan=top+news_top+news+index_businessweek+exclusives

Payback is a bitch isn't it!!

June 23, 2007 2:18 AM

Ya know it's the pension funds that own most of this fecal material!

Anonymous said...

"said the people, who declined to be identified because the details haven't been announced"


"The people" are none other than the Federal Reserve themselves. Federal Reserve is monetzizing this mortgage mess covertly. Smart money knows this and Hp'ers also now!




Hey Keith! Why not bring up the issue of who is actually bailing out this whole mess "covertly" ??

Anonymous said...

"They don't control the long end of the curve, and more interest is being demanded by investors



why the thought that they dont control the long bond? They can buy those also! and stated as much that they were willing! Long rates are NEGATIVE when inflation is being accounted for! how do you think that it Einstein?

SPECTRE of Deflation said...

Anonymous said...
"They don't control the long end of the curve, and more interest is being demanded by investors



why the thought that they dont control the long bond? They can buy those also! and stated as much that they were willing! Long rates are NEGATIVE when inflation is being accounted for! how do you think that it Einstein?

Treasuries are auctioned off on a regular basis. What happens when nobody buys at current price and yield? They must jack up the yeild until buyers come into the market.

Granted that all the Central Banks are doing everything in their power to keep this circus going, but at some point even they will say enough is enough. It happened under Volker and led to rates that wrung inflation out of the system while bringing real pain to the economy. I imagine we are approaching the point where our creditors demand the same from Ben.

Anonymous said...

Now that the fish are on the debt hook, its time to reel in the line (raise rates). Got debt?

Anonymous said...

At some point, coins will be worth more than dollar bills. Copper and nickel prices are skyrocketing. It reminds me of when they stopped using silver for coins because people were melting them down. We will see deflation in some asset classes (real estate, labor) and inflation in others (energy, food
).