tvb

Bailout Talks Lose Sight of the Cost Question

"This is flawed reasoning. If the assets are fairly valued at .35 then the assumption is that not all of the assets are performing. Afterall, the reduction in price is not due to a rise in interest rates, but the amount of defaults. In fact, given a fixed reasonable rate of return the price implies that only about 35% of the loans are performing. You still get only 6% of the pie, but now the pie is 65% smaller. (This is a highly simplified back-of-the-napkin calculation only, to show the fallacy of the argument above) Furthermore, if the bailout actually occurs, the 6% rate may not be enough to offset the rampant inflation that will ensue."

I am not a distressed structured bond analyst, so I can't say for certain what is behind the price of these bonds or what is the fair price. What I can say, though, as a corporate credit analyst/trader, is that the corporate credit market is currently substantially impacted by many technical facotors (banks having to sell down risk, hedge funds liquidiating, indiscriminate selling of any risk assets on headline fears, and momentum-chasing considerations.

I suspect (but don't know) that these factors are substantially worse in the more illiquid MBS market. I suspect that yields and credit spreads for these assets reflect a liqidiy and risk premium substantially higher than what is actually justified from current or expected default rates.

Having said that, yes my 18% yield comment is simplistic, but you get the point: there is a running yield on these bonds that I suspect is substantial (maybe not 18%, maybe less, maybe more). 18% would be consistent with the yield of many high-yield bonds which currently have strong cashflow (after servicing their debt) and solid businesses, but are oversold for fear/liquidiy reasons.