Sunday, March 2, 2008

Subprime -- "A funny presentation"

This is a nice diagram of how Collateralized Debt Obligations are constructed. All structured finance products, (CLOs, MBS, CMBS) are based upon this principle, but what changes are the underlying asset that the cash flows are based upon. In the case of Mortgage Backed Securities, the underlying cash flows that support the constructed finance product's price are pools of mortgage payments. There are other asset-backed securities that are based upon consumer credit card payments...

However, rather than get into the gory details, I've posted a link to an interesting presentation going around the web. It's titled "Subprime -- A Primer" and for what its worth, it's fairly accurate. If you have seen already, my apologies, but I actually heard two people talking about this very presentation on the train one night. I was going to try and show the different parts of the capital structure that subprime, and what all of the structured finance products (CDOs, CLOs, MBS, CMBS) are based upon, with CPRs and pre-payment rates, but I think this powerpoint cartoon pretty much tells you everything you need to know.

Link to Powerpoint on Subprime Cartoon

For what it's worth, most think that the amount of sub-prime exposure out there is well into $350 - $400B, as in Billions. So everytime you listen to a pundit on TV (CNBC, etc.) state that the last writedown by bank "x" signals the end or bottom, think again. At last count, with the big banks reporting their 2007 results, we're at less than ~$100B in writedowns, so most believe we have a long way to go.

The other issue is that while subprime "homeowners" have no incentive to make payments on a house that is worth less than their mortgage, and will thus enter foreclosure, foreclosure itself is apparently a process that takes a long time because there are a lot of costs and involved parties (legal, financial). So after Citigroup announces "$xxB" of writedowns, and folks say "oh good, we can now look forward to the future because we hit the bottom" realize that the Citi's of the world know there's more bad loans out there that they will have to writedown. But because this process takes so long to play out, the Citi's of the world won't be able to assess which loans are bad, thus can't write them off until they have some precision around the writedowns.

Net-Net: This will be a much slower unwind than the 2000 tech bubble bursting. Repricing assets happens quickly with assets that are traded fairly heavily and thus somewhat efficient in price.

But don't worry, Bernake, the Fed and W. Bush II apparently think that the US will not enter into a recession, given the stimulus package and rate cuts. Most on Mainstreet and Wall Street believe we're already in a recession. Who knows, maybe decelerating GDP growth isn't indicative of a recession if "inflation is still a threat." Too bad inflation is partially being driven by the Fed cuts, globalization, and the world's demand for oil. Oil is probably involved in most manufacturing processes, so where the price of oil goes, so too goes food and most other prices.

1 Comment:

Anonymous said...

Nice dispatch and this post helped me alot in my college assignement. Say thank you you for your information.