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Where Did All The Toxic Assets Go...Neutralised or waiting in the wings?



I was looking through Mark Zandi’s (of Moody’s) November 2009 written testimony to the Congressional Oversight Panel on the effectiveness of TARP.

I noticed this:

“It was unfortunate that the TARP program was unable to fulfil its original objective, namely to fund the purchase of troubled assets on the balance sheets of financial institutions. These assets are still on the balance sheets of these institutions and thus impairing the flow of credit. Institutions are uncertain of the value of these assets and thus their own capital adequacy”.

Notice: "Uncertain of the Value  of These Assets"

Well we knew all that, that's why PPIP went nowhere either, although that’s the first time I’ve seen it written down in black and white. And I didn’t hear of anyone on the Panel or Timothy Geithner jumping up and down saying “No-No that isn’t true”.

I have a few small questions:

1: I thought they had “Stress Tests” and those established the “value”.

2: I was under the distinct impression that a lot of “financial institutions” had put out audit reports, SEC filings, “management accounts” (the Fed doesn’t put out audit reports), that had the value of the holdings of those things written down in black and white on a sheet of paper, duly signed by some notable person as a true representation of the financial health of those institutions.

Like for example the Fed has now got $1.25 trillion “worth” of that stuff on its balance sheet, but they are not saying how much it’s “worth”.  My impression is that they bought it at “face” (in which case they might have a bit of a “surprise” when they try and sell it), although I can’t find any information on that, but what I really can’t get my head around is either:

a): The Fed know what that stuffs worth, in which case why aren’t they telling anyone how to be less "uncertain"?

b): They don’t know what its worth, in which case when the Fed  releases a summary of its assets why doesn’t is say, “We don’t know what our assets are worth”.

c): If they don’t know what they are worth, why are they buying them? That sounds a bit like signing an open ended cost-plus contract with Halliburton (in the good old days).

Same story for the FDIC Insured-Institutions; at the end of the third quarter 2008 they had $1.26 trillion of Mortgage-backed securities on their books, now those are “worth” $1.35 trillion (and by the way the good news is that the FDIC Insured-Institutions made a profit of $2.8 billion in Q3 2009).

What I don’t understand about that is:

a): How come the value went up – I thought house prices, foreclosures, defaults are worse now than then, or did they anticipate that completely ?

b): If they don’t know what those things are worth why don’t they write “Don’t Know, we think it might be “X” but we are not sure”.

c): How do they know how much profit they made of they don’t know what their assets are worth?

As a general question, another thing I can’t understand is how they knew what they were worth in the first place. OK…OK I know you will tell me that they worked that out from the simple Wall Street/Goldman Sachs line “they are worth what you can sell them for to someone dumber than you”.

So what’s happened?

Is it that Wall Street and the rest have found out that there aren’t any people dumber than they are they can sell that stuff to?  That’s encouraging to know….I suppose?

I suppose the good news is that we have finally found the floor and we can say without fear of contradiction that there are not any people in the whole world, dumber than the people who currently have toxic assets on their balance sheets.

Could that be a sign of “Green Shoots”?

Mark Zandi probably  doesn’t know what they are worth (otherwise presumably he would have said so), which is a bit of surprise, because presumably he knew what they were worth when Moody’s got paid a small fortune to slap AAA ratings on them (back in the good old days).

I mean surely there is another way to do a valuation of a mortgage-backed security, outside of standing on street corners trying to find people dumber than you are?

I used to work on a toxic asset assembly line, it wasn’t that complicated then (back in 2001), you worked out the value of the collateral (the price of the house), then you ran out a projection of future cash flows (you took a view on pre-payment, foreclosure, etc), then you put in where you thought two standard deviations lay from every planning assumption, set up the Monte Carlo, cranked the handle and out came the answer.

It’s not complicated, the only thing I never understood was why it was that when you did the valuation of the assets (I was typically on office buildings and shopping malls), why you weren’t supposed to give an opinion on what they would be worth in the future (like about the time you might have to sell them if there was a default).

I was told not to worry my pretty little head about that, and that anyway prices always go up (I was pretty low down on the food chain so I just said “Yes Sir”).

My point is, you put numbers into am Excel spreadsheet, the boxes where those numbers go haven’t changed; so what’s the problem?

OK some people got the numbers badly wrong last time they tried (that was called the credit crunch…Ooops), but the process is the same, you look at the data and make a decision.

The only explanations that I can come up with are:

a): There has been a secret terrorist attack and someone has put something in the water which has resulted in mass amnesia and everyone has forgotten how to value an MBS (outside of the “dumber than thou method”).

b): They never knew how to do the valuations in the first place, but they don’t want to admit that to anyone.

There is some evidence that might be true, for example in July 2003, International Valuation Standards Committee wrote to BIS saying that the valuations used (by financial institutions) as a basis for assessing capital adequacy, were “hopelessly flawed and bound to be misleading”. 

Translating that into plain English what that says is, “You guys haven’t got a clue how to do a valuation”.

There is no record of a reply going out

c): They know how to do a proper valuation, but they don’t want to tell anyone.

That’s would of course be a conspiracy theory, and I wouldn’t want to go there.

So Where Did all The Toxic Assets Go?

Mark Zandi has a pretty little chart from Thompson Reuters showing how many toxic assets were issued between 2000 and 2009 (RMBS, CMBS, ABS, CDO), add the ones done before and you get about $10 trillion.

Out of that I estimate they managed to sell $3 trillion or so to foreigners who were dumber than they were, so that leaves about $7 trillion.


>> I think about $500 billion got written off so far (I’m not sure).

>> The Fed say’s it’s got 1$ trillion which I presume is at “face”.

>> FDIC Insured-Institutions have about $1.35 trillion.

That’s $2.85 trillion, so where’s the rest hiding?


With Fannie & Freddie perhaps - their "fair value" is reported to be about $1 tillion combined, which leaves about $2.8 trillion here and there presumably with pension funds and insurance companies.

I wonder if they know what they are worth (and if they don’t are they telling people they don’t know), and if they do know, are they telling the truth?

The other thing that I don’t know and I can’t find, is how much gearing there was on that stuff, like on a 20% risk weighting which is what you could do when there were lost of very dumb people around, you could theoretically leverage that 49:1,  which case, any losses would be geared up in proportion.

Perhaps that’s why it’s so hard to find out who was the dumbest guy on the block who got stuck with that stuff, and why no one wants to know what it’s worth?

Perhaps not quite out of the woods yet...I wonder what happened to PPIP?


Disclosure: "No Positions"