The Time To Buy Is When Blood's In the Streets 12 comments
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As I mentioned in my previous post on the mortgage bailout, it seems clear that Bernanke and Paulson both think that mortgage backed securities are undervalued at current market prices (my "scenario 1" in the previous post). Bernanke refers to the difference between "hold to maturity" and "fire sale" prices in his congressional testimony.
Many commentators are trying to wrap their heads around this difference. To understand, it helps to have seen the collapse of a financial bubble firsthand. If you haven't (as, I suspect is the case with most academic economists), you are likely to cling to the idea that the market price of an asset is a good forecast of its actual value. However, this is completely wrong in the wake of a collapse. (And, certainly, the predictive power of the market price cannot hold at all times -- it is likely to be most wrong at the peak and in the aftermath of a bubble.)
The following false conundrum has been stated recently by numerous analysts, including Paul Krugman: "if Treasury wants to recapitalize banks it has to overpay for toxic assets, to the detriment of taxpayers; if it wants to pay fair prices for the assets then banks won't benefit." There is no conundrum if markets, at this instant in time, are systematically underpricing mortgage assets.
When the Internet bubble burst in the early years of this century, investors were so gun shy and under so much pressure that they would not pay even rationally justifiable prices for stakes in technology companies. Smart investors who were willing to put capital at risk could buy assets at fire sale prices and made huge profits. This is nothing more than fear and herd mentality at work. If herd thinking can lead to overpricing of assets, why not underpricing immediately following a collapse?
Markets overshoot on both the up- and the down-side!
These points are obvious to any trader... it's the academics with equilibrium intuitions who are struggling to understand! Note as I mentioned in the earlier post, the "hold to maturity value" can only be modeled using probability distributions for defaults, price movements, interest rates, etc. But I've been told many times by people in the industry that current market prices imply massive default rates which are unrealistically high.
WSJ has the best summary.
Related discussion: Paul Krugman , more Krugman , Economists' View , Brad Setser.
WSJ: ...Uncertainty in housing markets and the economy are forcing financial institutions to mark mortgage securities at fire-sale prices, rather than their value if held to maturity, effectively creating a vicious circle of more write-downs that further depress asset values, Mr. Bernanke explained.
Mr. Bernanke said the Treasury plan should have taxpayers buy the assets and hold them at close to their maturity value. Removing the assets, he said, would bring liquidity back to markets, unfreeze credit markets, reduce uncertainty and allow banks to attract private capital.
...In subsequent questioning, Mr. Bernanke distinguished between, on the one hand, “fire sale prices,” the ones that prevail “when you sell into an illiquid market” and, on the other, the prices that holders think the assets are really worth, sometimes described as “fundamental” values or “hold-to-maturity” value.
“The holders have a view of what they think it’s worth. It’s hard for outsiders to know,” Mr. Bernanke said. The point of an auction is to reveal those prices. “If you have an appropriate auction mechanism… what you’ll do is restart this market,” he added.
Paulson, while seeking maximum flexibility, said the Treasury is considering doing auctions one asset class at a time. He said the aim to bring “bright people” to work on the challenge of designing market mechanisms.
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Seriously, some of these assets are probably currently undervalued, but even under Paulson's plan, there is no reason to think that homeowners ability to service their debt will improve. It is very likely that the assets which you seem to think are undervalued now could be worth even less years down the road!
The only reason for Paulson to take on $700 billion of garbage with NO OVERSIGHT and NO ACCOUNTABILITY to anyone is that he is fully aware he will be overpaying. A lot.
Surprise to see you contributing articles to Seeking Alpha! I am a frequent visitor to your infoproc blog for a long time. I know you. You probably don't know me but one day you will.
Have you given some thought on noble metals. As a physicist you definitely need to have a look at their great potential:
stockology.blogspot.co...
Further, as a physicist you need to take another look at Cold Fusion. It's a real deal experimental science that will save humanity. Cold fusion has not died after 19 years. Instead more and more skeptical researchers have now joined the camp advocating for Cold Fusion research.
www.lenr-canr.org/
Mark Anthony
seekingalpha.com/autho...
The question of whether the government should over-pay for assets acquired has arisen. And the answer is no. But remember, the mark to market value is not necessarily the fair value of an asset, except for in an accounting sense. When a company acquires another, it virtually always pays a significant premium over the market value of the company. The target has a certain value to a buyer, which goes beyond its present worth; some of it comes from synergies post acquisition; more of it might come from the acquirer’s ability to use and profit from the acquired asset. In determining the transaction value, the price should fall somewhere between the market value and the value to the buyer. Keep in mind that in this case the buyer is United States. The principal deficiency causing collapsed market values is confidence; with a buyer such as the United States, confidence to an asset class returns and the asset is immediately more valuable.
and report back next year.
valuestockinvestors.bl...
The rights and wrongs of socialized banking and the mechanism are separate from understanding the impact on investments if this proposal goes through. If you think you know of quality assets that are cheaply priced, the major obstacle to committing capital (uncertainty about liquidity) will be reduced only if you really think that the next opportunity will not be significantly better.
His assumption is that Mortgage backed securities are at the bottom therefore it makes sense to invest in them. However, if this is a bottom it is clearly a "false bottom". Housing is still madly overpriced. As it keeps declining much more mortgages will foreclose making those securities obviously of no value even for those who doubt it today.
As everyone knows investing at the false bottom is much worse than investing at the top.
On top of this, if we compare USA to a private investor, the only analogy is with one already deep in debt. One who keeps evading Bankruptcy by constantly juggling more and more credit cards with initial teaser rates to pay minimum payments on older ones. The funds needed for this new "investment" may be only borrowed. By this our "investor" risks sharp rise in all those existing rates, with inevitable bankruptcy as the result.
Overall, it's an extremely bad article. I can't even be sure the author is honest in his arguments. While reading it I felt that he just want to sell obviously wrong conclusions by using whatever reasoning he is able to mobilize.