Well, they are "toxic" because they killed some very high profile investment banks and forced others into shotgun marriages. But most people refer to them as toxic because they have no value, and that's the farthest thing from the truth, as I discuss here.
Dennis Gartman discusses PIMCO's interest in these bonds.
GEITHNER’S PROGRAM MADE A BIT MORE SIMPLE:
To the best of our knowledge, after having slogged through a large number of articles over the weekend trying to discern what the new bank bailout/public-private investment program for the mortgage-back industry is, we’ve arrived at the following deeply simplified analysis. If we are wrong, we trust that one or two or twenty of our clients will write in to tell us so, and if they do, we’ll share that with our other clients around the world.
Simply put, it appears that the program can be broken down into two aspects. Firstly, Treasury wants to be able to lever upon the FDIC and the Fed to take $75-$100 billion in private equity to buy perhaps $1 trillion… or even a bit more… of various home loans and other “toxic assets,” getting them off the books of the banks and into the books of these newly created investment entities. Secondly, these private investor groups, along-side the government, will bid for various pools of bank loans and mortgages, with the FDIC guaranteeing financing. This is where the leverage comes in.
After the rather complex veneers are stripped from the programs in question, this is what we are left with. It is not all that complicated, although as always, the devil’s in the details. Already, PIMCO and Blackrock are aboard, with Mr. Gross of PIMCO stating quite clearly that if the government is prepared to lend money to these newly created investment entities at 2% for a protracted period of time PIMCO will be willing to bid 60 cents on the dollar for many if not most of the “toxic assets” in question.
We’ve learned never to take the other side of one of Bill Gross’ trades, having learned that very much the hard way back in the early 80’s. PIMCO’s track record since makes that all the more certain.
Given that most of these “toxic assets” have been discussed on The Street as worth as little as 20 cents on the dollar, PIMCO’s “bid” at 60 changes the dynamic rather materially. Banks that were insolvent at 20 cents are solvent, or nearly so, at 60. The psychology changes materially, and at bottoms that is often all that is needed to turn markets around.
So assets that were selling at fire sale prices - 20 cents on the dollar - when banks were forced to dump them to stay out of bankruptcy could very well be worth ay least 60 cents on the dollar to a smart investor like Bill Gross at PIMCO. And keep in mind that if PIMCO is willing to pay 60, the actual value is probably a lot higher.
There is a lesson here. Often the simplest ideas are the most profitable, and the fewer people who think like you do the more profitable it is. The idea that mortgage backed bonds are worthless was always a ludicrous idea. Real estate, the ultimate backing for these bonds, has declined in price but is not zero. Oh sure, the way that Wall Street sliced them and diced them into tranches made some of these tranches worthless, but they are easy to identify. The rest are hundred dollar bills that people refuse to pick up because they have been told they’re really “Monopoly” money.
Buying someone else's "toxic" assets - I predict - will make some people very rich.
2 comments:
The problem is that the product may have been leveraged within its structure so minor changes in the value of the underlying assets could totally destroy the security. What you described there would be the old fashion mortage backed bond and not the kind of structured product they are dealing with these days. The product itself could be leveraged say 10:1 and the buyers themselves could further leverage themselves say 10:1. Why do you think we get into this mess? Simple mortgage backed bonds, even with trances, would not have got us into this mess.
You are making it much too complicated and confusing what some hedge funds did with what the financial engineers did who created these bonds. The typical financial engineering was done by creating a number of tranches with the riskiest ones getting the highest yields in return for taking the first losses. The highest tranches were even more secure than a mortgage backed bond that was not sliced and diced this way since it had the lower tranches protecting it. The reason these bonds were bought was because they had higher yields than comparable treasuries giving pension funds, for example, ways of getting a better return. For an even better explanation go here.
Post a Comment