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Bailout Talks Lose Sight of the Cost Question

Sorry, but I really don't think that these secuirites are not going to be sold today with a running yield of 6% on the remianing performing loans. The risk premium for credit and, particular, strcuture credit, is much higher than that today. If 65% of the loans have already defaulted, investors are not going to AGAIN except a 6% yield on the remaining 35% of loans (6% was the annual the risk premium that was paid at the height of the credit bubble).

I'll give you a ancedotal comparison. High yield bond funds were selling below 200bps at the height of the credit bubble in 2007)...today that spread is closer to 700 basis points (500bps above where they were at the peak). That reflects the yield on the PERFORMING bonds...an apples to apples comparison to the yield a the peak. On top of the higher yield, the value of the principal (of the remaining loans) is now about 20% lowe, giving you higher recovery prospects on the bonds that do default in the future. The same would be true for a MBS...you would have a yield on the remaining performing secuirities which is I expect is al least 500bps wider than it was at is peaks (so you are talking a runiing yield of maybe not 18%, but at least 11% and I suspect actually closer to 18% given the liquidiy and technical factors currently impacting the market).

As for "why the distressed buyers sitting on cash aren't buying these if they offer such great return". Technicals...every bank in the world is over exposed and trying to reduce exposure. Furthermore, there are few true-long buyers on WallStreet...most are chasing headlines and momentum as they have to mark to market their positions daily and their investors don't have the patiernce to just sit and watch their investments fall because they are told they are "good long term value"...particularly for securities that the underlying investors, a step away from the market, don't understand.

What's happening in many credit markets, today, is like a reverse bubble...everyone knows they are oversold/cheap but can't afford to go long (or are often even short these securities) because they feel that short-term technicals will lower prices further...irrespective of the long-term value. It's like the reverse of what happened in early 2000, when many smart investors were long TMT stocks even though they knew they were vastly overvalue (they simply had to chase momentum and trends).

Disclosure: I do not follow or analyse these MBS securities and I am simply extrapolating from what I have seen in the corporate credit markets. I do not ruly know if these MBS securities are oversold, but strongly suspect that this is the case.

Bailout Talks Lose Sight of the Cost Question

"The present value of the interest payments is next to irrelevent -- unless you are a Wall Street "analyst" and forget to take the present value of the interest costs... This ranks right up there with EBITDA -- or the most recent Wall Street stupidity: earnings before all costs."

Wall Street needs to learn some basic math skills. Well, if you are the Treasury and receiving (hypothetically) 18% in annual returns (which incorporates expected interest payments less expected default losses) on your investment and your cost of capital is 3.5%, is the present value of your annual payments really 0? Also, I believe the statement was that they would make 1 billion -- that is an absolue amount, not the NPV of future earnings.

Maybe NPV is more relevant, but get your facts straight and get off your condesending high horse. Actually, strike my last comment, I agree that most analysts on Wall Street are morons and need some basic math lessons.

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.

Bailout Talks Lose Sight of the Cost Question

The 43% is only the capital appreciation. If these loans were paying 6% per year at par (don't know if that's the case, just estimating), the running annual yield on the investment (at 35 cents on the dollar) is almost 18% per year. Perhaps that helps bridge the gap to the number he comes up with in his calculation? Don't know, just thinking out load.

Curing the Credit Crisis: A Better Alternative Plan

I don't think Bernake is suggesting paying full price, as you imply (read his comments more closely). Rather, I believe he is suggesting paying a price that more closely represents the fundamental long-term value of the securities (which, of course, incorporates folreclosre/default expectations for the loan pools and will likely be well below par -- I believe Gross at Pimco is estimating the Treasury could pay about 65 cens on the dollar and will yield a substantial return on this "bailout" investment. The challenge is determining what is the true fair price as it is by no means a straightforward calculation and is subject to subjective considerations.

The Real Secret to Fractional Banking

You have to use overall inflation to calculate real rates, not cherry-pick the most appreciated asset classes of the past year (e.g. gold). If you are going to arbitrarily chose an asset class to calculate real rates, try using the deflated housing prices of the past year. Makes just as much sense as using gold (none). You could have made your same arguments a year ago -- and those who invested in 10 year treasuries last year (at around 5% yields) made substantial returns -- particularly compared to those who lost tons in the equity (around 20% from the peaks) and housing markets. I'm not saying that treasuries are attractive now (I don't think that they are), but your analysis is flawed.