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Michael K. Edwards  

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  • Leverage Aside, MBSs Were Always a Bad Trade [View article]
    The resource that I have found most helpful in understanding the MBS debacle is _The Handbook of Mortgage-backed Securities_, by Frank J. Fabozzi. Originally published in 1985 and now in its sixth edition (2005), it is quite literally the textbook on how mortgages are sliced and diced into boutique portfolio-balancing securities.

    For what it's worth, my candidate for the villain of the piece is the rise of the retail investor with no analytical skills and no concept of the role of public policy in shaping the investment landscape, shepherded into the securities market by well-meaning but ultimately foolish government programs. In the US, the 401(k) is the most egregious example -- an attempt to reduce investment to a sort of 8th grade reading comprehension test. (You are 42 years old. According to the text you have just read, what percentage of your portfolio should be in bonds? Here are the Morningstar blurbs for three funds constrained by prospectus to purchase "AAA" securities. Can you choose the one whose 5-year yield is 0.03% higher than the other two?)

    The result has been a huge, irrational demand for specific synthetic assets (index funds and AAA ABS). Not much different from a gold rush, really, in which a narrow, irrational demand for a particular metal with limited industrial uses results in a huge waste of labor to produce mountains of tailings, lakes of toxic waste, and shiny bricks and trinkets under lock and key. Sadly, the MBS gold rush's "toxic waste" is not just numbers on hard disks; it's land, materials, and labor poured into worthless tract homes in silly places, and the idling of otherwise healthy industries that can't finance receivables or actual productive assets.
    Mar 6, 2009. 01:54 PM | Likes Like |Link to Comment
  • Settlement Auction for Lehman CDS: Surprises Ahead? [View article]
    Final results are in: 8.625%. Could have been crazier; but not pretty. It will be ... interesting ... to see how cash settlement on the 21st goes.
    Oct 10, 2008. 02:11 PM | Likes Like |Link to Comment
  • Settlement Auction for Lehman CDS: Surprises Ahead? [View article]
    I seem to have gotten it half right. Yes, the auction results will be insane. No, they won't be insane in the direction I anticipated. The inside market fixing is 9.75% and the net open interest is $4.92 billion to *sell*.

    So the maximum possible Final Price is 10.75% of par - if big players decide they want the actual bonds (offered for physical settlement) at that price, and place Limit Orders accordingly. At the other extreme, if there aren't enough Limit Orders to buy at any price, the Final Price could be *zero*. Yes, that's right (see Section (7)(d) of the Auction Methodology in the Lehman CDS Protocol); the Final Price, used as a reference price for CDS cash settlement, can be *zero*.
    Oct 10, 2008. 11:48 AM | Likes Like |Link to Comment