Awful Investing Advice of the Day, Distressed-Mortgages Edition

Michael Osinski has an interesting article on nymag.com about how he, a CMO-structurer-turned-oyster-farmer, is playing in the riskier end of the distressed-debt market.

I have no illusions about the risk of what I’m doing. Buying mortgage-backed bonds today is putting your finger to the wind in a storm, like you’re standing on a seawall facing a nor’easter. You know the second wave of defaults is coming. It’s forming out past Montauk, swelling in Gardiners Bay, about to smash into your seawall. Will it knock you down, rip your boat from its cleats, and scatter your oyster cages all along the rock pile?…

I buy my bonds through a former colleague named T…

You have to treat every bond like a time bomb, carefully assessing how much time you’ve got before it blows up in your face.

T. is selling me CMO bonds. I’ve bought seven of them in the last three months.

It’s a good, well-balanced piece, which shows how a sophisticated financial market professional is taking very careful and calculated risks with money he can afford to lose. He also knows, of course, that if he does end up losing that money, he has no one but himself to blame.

And then, at the end, it goes horribly, horribly wrong:

So how can you consider joining Michael Osinski and invest in toxic assets?

No!!!

The answer to that question is Do Not consider joining Michael Osinski. Do Not invest in toxic assets. And, whatever you do, Do Not start buying shares in things like BKT and HSM and TSI and FMY and HTR — ticker symbols all helpfully provided by nymag.com — especially if you think that in doing so you’re somehow replicating what Osinski is doing. You’re not.

Osinski is buying a very small number of very carefully-vetted bonds. This is the classic “PA” trade, where financial market professionals buy obscure instruments for their personal account in sizes which simply don’t scale up to the sort of money thrown around by institutional investors. Osinski’s bought seven bonds in three months, and I’m sure he went over each and every one in great detail with his friend T. That’s small-scale, highly-informed investing — the exact opposite of throwing your money at the Helios Total Return fund and hoping for the best.

Yes, the website does urge its readers to “be especially careful here”. But that doesn’t excuse spending 600 words on what you should do if, in a moment of recklessness, you decide that you want to ape the investing strategy of an oyster farmer who has just written a feature article for nymag.com, and who knows much more about what he’s doing than you ever will.

Comments

[Dialectical...:]

Truly you are right. But then I would wonder about ANY investor who buys something on the basis of an article they read. They say the retail investor underperforms the S&P and this kind of investing is why. If you throw your money around at things you don't understand, you deserve what you get. This is as true for HTR as it is for three card monte or the lottery. How many people bought GM when they read something about it emerging from bankruptcy? At some point people need to understand that it is their job to know what they are buying or simply treat it as a crap shoot and live with the consequences. I agree with your point 100%, but it is pathetic that it even needs to be said.

Oct 15 12:59 AM

[Daniel Eskin:]

Wow that almost seems like a satirical piece that people would be lured into and then the ending would really hit you in the forehead. Investing in toxic assets shouldn't even be called investing, but more appropriately trading or even gambling.

I was actually listening to a podcast today and apparently AIG (considerably toxic) is starting to get analyst coverage again today. How the heck is ANYBODY claiming that they understand what is going on in that company? Some people...

Check out my blog at: www.youngandinvested.com

Oct 15 12:01 PM

[ts2:]

Very very good commentary Felix

Oct 15 01:20 PM

[sethmcs:]

You can make serious money in vulture investing. Even buying distressed debt listed on the exchange. People do it all the time. The problem is most people cannot understand or assume the level of risk of such investments. I am not surprised that vultures are picking over the bones of toxic debt. I have said many times during the panic of 2008 that the toxic debt was worth more than the market valued it at.

Oct 16 04:18 AM

[Wizler:]

with that article he is lining up some suckers to buy those bonds from him...a quick profitable flip is what sell siders like right? Nothing like some PR tactics to generate interest...oops did I just say that

Oct 16 08:30 AM

[Andrew Butter:]

I detect the whiff of schizophrenia in the air.

Everyone appears to be quite comfortable with the idea that for example FDIC insured banks have $1.3 trillion of MBS (i.e. toxic assets) on their books valued for the purposes of assessing their capital adequacy and solvency, apparently at "face", i.e. what they paid for them.

Yet when people who know about these things aim to go out and buy them for 30 cents on the dollar, it's as if the world fell down.

As Osinski points out the way you value those things is very simple, you put in a number for the rate of increase (or decrease) of house prices, another number for the rate of foreclosure, plus one for what you will get from that, plus another for the unlikely event of "prepayment" (that's when the borrower pays back the loan in full, in advance which used to be the main concern - not so much of a "concern" these days).

Then you crank the handle and bingo.

The risk is that you put the wrong numbers in, that was always the risk, in the old days people put in a 5% a year growth in house prices and a minimal default rate.

So they got the number wrong, they lost. Nothing changed, then you had to make a forecast, now you have to make a forecast.

What's the big deal?

Oct 16 09:01 AM

[Cyrus the G...:]

I personally work for an asset management company that is engaged in the business of distressed debt. We purchase collateralized debt on a grand scale (hundreds of millions of dollars per transaction).

I witness everyday the comprehensive and thorough measurements and analysis we must undertake in order to price out the effective value and the future/anticipated value of these toxic assets we purchase.

As a result, we are very profitable. We are actually one of the big players in this business right now. We dont necessarily buy bonds; we buy the actual toxic assets. In doing so, we have claimed stake to the underlying security and can appropriately measure profit through various exit strategies.

However, to the point of the author, I have seen people (i.e. companies) try to get into this business and do so blindly. I have seen hedge funds outbid us on pools of assets, win the pool, and only to come back to us months later offering us the pool at a loss to them simply because they did not understand the factors involved. It must take into account deflation, asset condition today (discounted), and also the potential ROI on it depending on the different market forces.

I agree with the author in the point that this is a very risky business. Most people dont understand the nature of what is happening in the economy right now, specifically with these assets and how toxic they truly are. We are in the midst of a deflationary rebalance and all assets today are worth less the minute purchased potentially.

Good post.

Oct 19 03:26 AM