Editore"s Note
Tilting at Windmills

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November 9, 2007
By: Kevin Drum

LIQUIDATING....Earlier this week I was musing about the problem of valuing all the CDOs and SIVs that are at the core of the subprime/credit crisis. It's certainly true that if no one is confident about how to value these instruments then the market for commerical paper freezes up, causing the broader financial markets to freeze up in turn. But the reason I was puzzled about this is that CDOs are collections of underlying securities, and if push comes to shove you can always unbundle the CDOs and put the underlying stuff on the market. It's not pretty, but it would be a way to put a value on everything.

Today, via Atrios, we learn what happens if you announce that you're going to do exactly that:

[Standard & Poor's] said it slashed its ratings on Carina CDO Ltd's top tranche of securities by 11 notches to the junk level of BB from the top-notch triple-A after it received a notice on Nov. 1 saying that the controlling noteholders had told the trustee to liquidate.

....The trustee of the Carina CDO has started selling the asset-backed securities — residential-mortgage backed securities and CDOs — making up the CDO at the direction of the structure's noteholders, S&P said.

....The ratings cut on the Carina CDO is more severe than would be justified by the deterioration of the underlying assets because a decision to liquidate would depress prices and affect all notes that were issued, S&P said.

Italics mine. Like Atrios, I don't really understand exactly what's going on here. But it sure sounds like S&P is sending a message to anyone else who might be thinking of liquidating a CDO and thereby revealing what the underlying assets are really worth. Are they really that scared? Any experts care to weigh in on this?

UPDATE: Tanta from Calculated Risk doesn't quite answer all my questions (who could?), but in comments she answers some of them:

The really relevant bit is this: "after it received a notice on Nov. 1 saying that the controlling noteholders had told the trustee to liquidate."

CDOs are not in the normal course of events managed by "controlling noteholders"; they are managed by a portfolio manager on behalf of the noteholders. However, lots of these deals have verbiage in the deal docs that say if certain "trigger events" happen (usually, there is insufficient credit enhancement for the senior noteholders in the form of overcollateralization), the senior noteholders can take control of the thing from the portfolio manager. (They then become the "controlling class.") They can decide whether to keep the deal going, if it's passing through any cash flow at all, or they can decide to start liquidating.

Thing is, in a nutshell, as soon as you have any decision made by a controlling class, you already have a CDO in big trouble, because it's already gotten to the point where the noteholders took over from the manager, and this probably happened because the deal isn't generating enough cash flow to fund its required overcollateralization. So it's not like any old CDO selling assets, it's like a CDO that has already be repossessed by its noteholders selling assets. Of course, it's possible that the original deal underwriter is also a senior noteholder and therefore part of the controlling class. If that is so--I'd have to look it up for this deal--then there's really the potential for a nasty conflict of interest.

The other pertinent language is "a decision to liquidate would depress prices and affect all notes that were issued." The stress on "all notes," not "depress prices." The senior noteholders are supposed to have the right to take control in order to protect their interests (one of the perks of being in senior position). You expect a liquidation to hurt the junior noteholders more than the seniors. If, however, this action really is driving down the price of the senior notes, not just the juniors, then something very curious is going on. The rating agency may be reacting to a really badly written deal document that gives "controlling class" rights to someone with interests that are not really aligned with the rest of the senior noteholders. This can also mean that somebody didn't hedge a position as advertised, leaving no choice for the controlling class but to liquidate even when it would do better by allowing the deal to continue to cash-flow.

It is a long explanation and it's hard to put in a nutshell. That is why your basic business press doesn't even try to explain it, and ends up writing articles that confuse everybody.

Kevin Drum 2:13 PM Permalink | Trackbacks | Comments (51)

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Comments

Damn now I want to support Carina for doing the right thing even if it hurts and panicking the plutocrats, but they also made the stupid decisions in the first place.

AAAAAH!

Oh wait. I have no power to affect any of this.

In that case, Go Carina! Go!

Posted by: MNPundit on November 9, 2007 at 2:16 PM | PERMALINK

Unencumbered as I am by any special knowledge I am completely free to speculate.

It seems to me the general idea was by bundling together a buck of junk it would actually be worth more than the sum of the parts. Very gestalt. Kinda like at an auction where they build a pile of junk and add to it until someone finally bids. Or like when they sell thousands of 'unsorted' pennies to collectors who hope they can find a valuable coin in the lot.

If you bust up the group you remove the illusion of possible riches.

That's my (probably worthless) anaylsis.

Posted by: Tripp on November 9, 2007 at 2:28 PM | PERMALINK

They are terrified. This is why you see so many rats in Armani scurrying around Wall Street. The house of cards is teetering.

Posted by: troglodyte on November 9, 2007 at 2:30 PM | PERMALINK

If you want to know what's really going on, check this site every day:

http://lifeaftertheoilcrash.net/BreakingNews.html

Posted by: Speed on November 9, 2007 at 2:32 PM | PERMALINK

I personally think the rate cut was deserved, and 'bout time. I don't think it'll impact those companies that have little to no exposure in subprime.

But we'll see.

Posted by: Tony Shifflett on November 9, 2007 at 2:35 PM | PERMALINK

The ratings cut on the Carina CDO is more severe than would be justified by the deterioration of the underlying assets because a decision to liquidate would depress prices and affect all notes that were issued, S&P said.

I thought S&P ratings were supposed to be based upon *risk* not *price*. Junk is *junk* because it is risky, not because it is cheap. Of course junk is cheap because it is risky, but not necessarily the other way around. The price depression they are talking about above is because of increased supply, not increased risk.

What gives?

Posted by: Disputo on November 9, 2007 at 2:35 PM | PERMALINK

Following all this stuff as an outsider, it looks like the big problem the investment banks had with all these funky vehicles isn't that they couldn't find a price for it: it's that they very easily could find a price for it, and didn't like said price at all.

Once somebody breaks the dyke, the IBs can't continue with the pleasant mark-to-fantasy valuation model they've been using up til now. Of course, S&P is the well-paid shill that has been blessing these turds, and its executives are now likely contemplating what kind of criminal, civil, and legislative beatings are coming their way right now.

Posted by: ericblair on November 9, 2007 at 2:38 PM | PERMALINK


"Any experts care to weigh in on this?"

God, where's Al when you need him?

Out to lunch, I guess.

h

Posted by: h on November 9, 2007 at 2:43 PM | PERMALINK

Speed: Oh please. I believe in peak oil but let's not reference that histrionic Life After the Oil Crash site and author, with it's book that is little more than a college student's FAQ.

I like analysis. Not mindless and repetetive Kunstlerian fixations.

Posted by: General Specific on November 9, 2007 at 2:45 PM | PERMALINK

I thought S&P ratings were supposed to be based upon *risk* not *price*. Junk is *junk* because it is risky, not because it is cheap.

Any financial propellerhead out there can correct me, but the basic way it was supposed to work is this:

Yes, these loans by themselves are risky. So we're going to throw them all together in a big pot, and divide them into tranches (slices). The investors who buy the senior tranches get first dibs on every payment, more or less. So, even though each loan is risky, there's a very good chance that at least enough of these loans will pay every month to keep the senior tranches current. The lower tranches take their chances, and have way lower ratings.

The problem with all this financial engineering, of course, is that you're assuming that all these individual loans won't all take a crap at the same time, like, for example, if the housing market goes to hell. Oops.

Posted by: ericblair on November 9, 2007 at 2:46 PM | PERMALINK

I think there's at least 4 things going on.

First, by unbundling assets, even ones in the same tranche, you remove the self-hedging nature of the bundle. Owning a bunch of (more or less) independent assets allows you to predict your expected losses much more precisely than owning just one, so the risk of the bundle is lower than that of any individual asset, so the price of the bundle is higher than the sum of the individual assets. (This is why insurance companies make money.)

Second is the simple supply-and-demand effect mentioned upthread. Selling assets, especially when nobody's buying them, depresses the price for everybody.

Third is, the whole SIV thing almost certainly was a bit of a speculative bubble, thanks at least to their novelty, and perhaps also due to some logrolling among sellers and regulators. The shiny balloon is finally coming to earth, with predictable consequences.

And the fourth is the usual panicked-herd behavior of the market. The same lemming-like behavior that ran the prices much higher than justified is now running them lower than justified.

As to whether there's some active "punishment" going on, I dunno. That suggests both collusion and some degree of altruism (if only for one's fellow thieves) that I think is beyond typical Street behavior.

Posted by: bleh on November 9, 2007 at 2:50 PM | PERMALINK

I think all this means is that Carina is a price-maker, not a price-taker. So if they sell off, then they send the price of the asset they're off-loading down, including similar assets they want to keep.

Posted by: gfw on November 9, 2007 at 2:51 PM | PERMALINK

Like Tripp I confess that I am "Unencumbered as I am by any special knowledge" of this subject.

My understanding is that the underlying value of the securitized investment vehicles, composed of bundles of mortgages or other underlying asset, has always been rather amorphously determined. Depending, perhaps, upon ones point of view or profit point.

Perhaps Carina holds lots of SIVs supported by underlying bundles of mortgages which the issuer knew upon origination couldn't be repaid, a fact Carina's "controlling noteholders" understand.

Why wouldn't a prudent manager try to sell out of an investment that soon will be worth nothing in hopes of recovering a portion of what was invested?


Posted by: Chris Brown on November 9, 2007 at 2:51 PM | PERMALINK

I sort of concur with ericblair, but I might also add that a liquidation is a little bit different than a bundle. For one thing. There's no mark-up. It would be the same as if Ford announced that instead of selling their cars at retail while continuing to make more, they are going to liquidate their entire inventory. It suggests that what you've got is no longer a going concern. It's a panic move, and not a move of a company in a strong position to weather a storm.

Posted by: Inaudible Nonsense on November 9, 2007 at 2:53 PM | PERMALINK

where's the kitties....

Posted by: linda on November 9, 2007 at 2:54 PM | PERMALINK

I think the myth of "bundling" the tranches of different assets is that they won't all, or even mostly, be bad. This is turning out not to be true in mortgage-backed vehicles when there's a real housing bust. So by unbundling, you're not just setting a realistic asset value, you're destroying a myth. And you get punished.

Posted by: David in NY on November 9, 2007 at 2:55 PM | PERMALINK

David in NY said what I was going to say, in just a slightly different way.

In essence, Carina is being punished for no longer playing faith-based economics.

Posted by: SocraticGadfly on November 9, 2007 at 3:03 PM | PERMALINK

My risky assets are entangled with your risky assets. By measuring a few of my risky assets, we collapse the wave function and know what the measurement of your risky assets are through the EPR Financial correlation otherwise known as "Mark to Market Valuation."

This can lead to a cascade reaction, perhaps even a chain reaction, and an implosion.

S&P did the right thing with their SCRAM.

Hope that helps.

Posted by: jerry on November 9, 2007 at 3:05 PM | PERMALINK

>"I don't really understand exactly what's going on here"

Here it is in common language:

If everyone liquidates their 'junk' all at the same time it becomes worthless. [i.e. The market is flooded beyond it's ability to absorb the unloading].

Imagine that the subprime mortgages are turds and there are always has a certain number of turds floating around.

You, as a traditional lender, didn't want to accumulate too many turds in your portfolio. So, when you had as many turds as you could bear, you didn't create any more. [turds=bad loans].

Aha! The financial genuises decided if you ground up a turd and baked it in a chocolate cake you could still sell the cake. The frosting would hide the turds. With this simple ploy you could sell all the turds you could accumulate and make a fortune!

So the lenders jumped on the opportunity and ground up trainloads and trainloads of turds and baked them into chocolate cakes... and sold them en masse to the masses.

Alas, now all the folks that bought those nice-looking chocolate cakes have discovered just how many turds are in there and they want to sell their cakes to some other fool. In late 2007 the supply of fools has run dry and nobody's buying.

Posted by: Buford on November 9, 2007 at 3:07 PM | PERMALINK

Looks like the lawyers are already trying to make a buck out of this: http://www.sparerlaw.com/cdoinv.html

What a bunch of nonsense. Everyone knew that CDOs were speculative, illiquid products. Just like it was general knowledge that the ratings agencies were in bed with the issuers. Anyone who invested in CDOs should go crying to the courts when they lose money.

Posted by: Brokeher on November 9, 2007 at 3:08 PM | PERMALINK

It's just like my grandma used to say:

If you put bullshit in a box you can sell it to some damn fool as long as you never tell 'im what's inside.

Grandma had a mouth on her that could make a longshoreman's ears bleed.

Posted by: Quaker in a Basement on November 9, 2007 at 3:28 PM | PERMALINK

I cannot weigh in on S & P's decision making, except to wonder if dropping their ratings eleven 'notches' undermines all of their ratings and thus their own business and if a big hitter, like CITI, is making them do it.

If a company could liquidate their CDO's and save their business, they probably ought to do it before everyone else does.

Posted by: Brojo on November 9, 2007 at 3:29 PM | PERMALINK

A couple points.

First, the Carina CDO is not a SIV. It's a CDO trust. SIVs are off-balance sheet financing vehicles used by financial institutions. CDO trusts are generally vehicles that rely on offshore debt financing, though I don't know this particular brand.

Second, obviously you don't get top dollar for an asset if you announce that you are having a liquidation sale. Sometimes retail stores use this as a gimmick, saying that they are having a liquidation sale to make people think prices are lower, but the reason the gimmick works is that everyone knows that in true liquidation sale, prices will be low. So S&P is saying the same an appraiser at, say, an art gallery would say: "If you have a liquidation sale, the values I ascribed to these assets no longer hold."

Third, the trade press is full of announcements about people forming funds to buy distressed assets. Expect some bottom feeders to make a lot of money off of whatever Carina sells. I know people who moved to Park Avenue (in NYC) by buying stuff from the Resolution Trust Corp., resolving the issues and reselling.

Posted by: y81 on November 9, 2007 at 3:37 PM | PERMALINK

"So the lenders jumped on the opportunity and ground up trainloads and trainloads of turds and baked them into chocolate cakes... and sold them en masse to the masses."
Posted by: Buford on November 9, 2007 at 3:07 PM
^^^^^^^^^
Thanks for the turd analogy. It is spot on and haven't stopped laughing yet.

Posted by: Doc at the Radar Station on November 9, 2007 at 3:55 PM | PERMALINK

Grandma had a mouth on her that could make a longshoreman's ears bleed.

Posted by: Quaker in a Basement

Lucky Grandpa!

Posted by: Econobuzz on November 9, 2007 at 4:05 PM | PERMALINK
So by unbundling, you're not just setting a realistic asset value, you're destroying a myth.

In the market, the common perception of value is value. Its the one place where enough people believing something really does make it true.

Posted by: cmdicely on November 9, 2007 at 4:07 PM | PERMALINK

These ABX indexes give you a pretty good idea what is going on:

http://www.markit.com/information/products/abx.html

Even the triple-A's have come down from highs around a hundred to the seventies.

Posted by: Chris/tx on November 9, 2007 at 4:08 PM | PERMALINK

Alas, now all the folks that bought those nice-looking chocolate cakes have discovered just how many turds are in there and they want to sell their cakes to some other fool.

Is that why Congress's approval rating is so low?

Posted by: Econobuzz on November 9, 2007 at 4:13 PM | PERMALINK

A primer on what the ABX index is:

The ABX Index is a series of credit-default swaps based on 20 bonds that consist of subprime mortgages. ABX contracts are commonly used by investors to speculate on or to hedge against the risk that the underling mortgage securities are not repaid as expected. The ABX swaps offer protection if the securities are not repaid as expected, in return for regular insurance-like premiums. A decline in the ABX Index signifies investor sentiment that subprime mortgage holders will suffer increased financial losses from those investments. Likewise, an increase in the ABX Index signifies investor sentiment looking for subprime mortgage holdings to perform better as investments.

Posted by: Chris/tx on November 9, 2007 at 4:16 PM | PERMALINK

The short version (maybe I'll do a post on my own blog on the longer version if I get a chance):

The really relevant bit is this: "after it received a notice on Nov. 1 saying that the controlling noteholders had told the trustee to liquidate."

CDOs are not in the normal course of events managed by "controlling noteholders"; they are managed by a portfolio manager on behalf of the noteholders. However, lots of these deals have verbiage in the deal docs that say if certain "trigger events" happen (usually, there is insufficient credit enhancement for the senior noteholders in the form of overcollateralization), the senior noteholders can take control of the thing from the portfolio manager. (They then become the "controlling class.") They can decide whether to keep the deal going, if it's passing through any cash flow at all, or they can decide to start liquidating.

Thing is, in a nutshell, as soon as you have any decision made by a controlling class, you already have a CDO in big trouble, because it's already gotten to the point where the noteholders took over from the manager, and this probably happened because the deal isn't generating enough cash flow to fund its required overcollateralization. So it's not like any old CDO selling assets, it's like a CDO that has already be repossessed by its noteholders selling assets. Of course, it's possible that the original deal underwriter is also a senior noteholder and therefore part of the controlling class. If that is so--I'd have to look it up for this deal--then there's really the potential for a nasty conflict of interest.

The other pertinent language is "a decision to liquidate would depress prices and affect all notes that were issued." The stress on "all notes," not "depress prices." The senior noteholders are supposed to have the right to take control in order to protect their interests (one of the perks of being in senior position). You expect a liquidation to hurt the junior noteholders more than the seniors. If, however, this action really is driving down the price of the senior notes, not just the juniors, then something very curious is going on. The rating agency may be reacting to a really badly written deal document that gives "controlling class" rights to someone with interests that are not really aligned with the rest of the senior noteholders. This can also mean that somebody didn't hedge a position as advertised, leaving no choice for the controlling class but to liquidate even when it would do better by allowing the deal to continue to cash-flow.

It is a long explanation and it's hard to put in a nutshell. That is why your basic business press doesn't even try to explain it, and ends up writing articles that confuse everybody.

Posted by: Tanta on November 9, 2007 at 4:21 PM | PERMALINK

Kevin Drum asks:

Are they really that scared?

Short answer? Yes. We are at a point in this exercise where cartoon physics applies.

Posted by: Kevin Bell on November 9, 2007 at 4:24 PM | PERMALINK

Why is Kevin Drum such a good friend of David Brooks?

I think Washington Monthly is like TNR, owned by a bunch of Republicans that went out of their way to find Dems willing to trash liberal parties and ideas, not that I think Reagan was a racist or anything but why the link? Is Brooks calling in for reinforcement? I mean, since Kevin is into explaining how torture is a glass half-full.

IS this going to lead to Bush being compared to Reagan again because there is no comparison. Reagan torn down the wall between Russia and Bush put it right back up again. Reagan didn't use torture, use wiretapping, or give unbid contracts nor did Reagan use fraudlent evidence to start a war. What gives?

Posted by: Me_again on November 9, 2007 at 4:24 PM | PERMALINK

obviously i don't know exactly what's going on, but if they were to unbundle these cdos, what they would find is an entire range of values within each bundle, some pieces much more valuable others.

an organization i was involved with had a similar experience when trying to evaluate its portfolio of telecom-related debt securities earlier this decade. if they had tried to liquidate all their stakes all at once, it would have meant losing nearly a billion dollars outright. but instead they managed their way out of the morass of bad paper over the next two years and ended up losing substantially less on their initial investment - somewhere on the order of "only" 400 million... sure, in some cases they had to write off 100% of the stake, but in most they were able to limit their write-offs to mere cents on the dollar...

i think something similar is being implied here. sure, there is a lot of junk in these bundles, but there are also plenty of worthwhile mortgage securities - fixed rate 30 years good payment history - that would always be a worthwhile investment to maintain... the evaluation in this case sounds like an average estimate (albeit a rather negative one) of the overall portfolio... there will be outliers on both ends...

Posted by: tom on November 9, 2007 at 4:29 PM | PERMALINK

It sounds as though this CDO is actually one of the easier ones to un-bundle. For anyone willing to work through it, this excellent post from Naked Capitalism does a good job of explaining why, in many instances, liquidation a la Carina might not even be possible.

(And yes, they ARE that scared - remember, when Bear Stearns kicked this whole thing off, the only thing that most of the financial world cared about was avoiding any sort of price discovery through liquidation that would force everyone else to mark down their own stuff. Well, it's happening now...)

http://www.nakedcapitalism.com/2007/08/extreme-measures-ii-gillian-tett-at.html

Posted by: Dave L on November 9, 2007 at 4:39 PM | PERMALINK

But it sure sounds like S&P is sending a message to anyone else who might be thinking of liquidating a CDO and thereby revealing what the underlying assets are really worth.

Remember that S&P and Moody's, like Lucy, have a lot of 'splainin' to do. They were the ones who cheerfully decided that there was a way to scramble the obligations in a way that was both investment quality and allowed the sponsors of these things to make money on the sale of the CDO tranches. Did the sponsors really decrease the risk as much as advertised? Apparently not, but the NRSROs had bought into the whole program. The real question that we have to ask tomorrow is "are bond ratings worth the paper they are printed on?"

Posted by: freelunch on November 9, 2007 at 4:39 PM | PERMALINK

Tanta,"a decision to liquidate would depress prices and affect all notes that were issued."

Good points, I think the rating agency concern is that if this particular CDO liquidates, the prices obtained are then "the market" for all such paper. Others holding such paper would no longer be able to argue value in theory, they'd have to mark to an actual event.

Posted by: TJM on November 9, 2007 at 4:57 PM | PERMALINK

Here's an interview with Jim Rogers (co-founder with G. Soros of the Quanum Fund).

Note this segment:Well, if they raise interest rates, the dollar is going to go through the roof,

I'm making money on their foolishness, on their stupidity. But it's not good for the country, what they're doing.

Ben Bernanke has been writing and reading about printing money for all his life, and we've now given him the printing presses. I mean, he's going to run them

Read the transcript, very interesting.

Posted by: TJM on November 9, 2007 at 5:12 PM | PERMALINK

TJM, I don't think that's a big problem. I am not familiar with this particular CDO vehicle, but, in general, the assets of each CDO are unique. On the one hand, that makes them difficult to value, but it also means that one is not a benchmark for the others.

Even in this market, CMBS and whole loans change hands, outside of liquidation contexts, every week. The prices aren't very good, but they aren't at fire sale levels. Those prices are surely a better benchmark for any continuing CDO than whatever Carina gets in liquidation.

Posted by: y81 on November 9, 2007 at 5:13 PM | PERMALINK

Benjamin Graham and other wise investors, such as Warren Buffett, have long admonished, "never invest in something you don't understand".

Since it is pretty evident there is no one on this blog, or on Wall Street apparently, that understands how these instruments are supposed to work, no one should have put a nickel into them.

As always, caveat emptor.

Posted by: The Conservative Deflator on November 9, 2007 at 5:28 PM | PERMALINK
In the market, the common perception of value is value. Its the one place where enough people believing something really does make it true. cmdicely

There is a maxim in Sociology, "What is believed to be real, is real in it's consequences."

Posted by: Dr. Morpheus on November 9, 2007 at 5:50 PM | PERMALINK

Kevin,

Read Roger Lowenstein's book _When Genius Failed_, about the failure of Long-Term Capital Management. It is a fairly approachable look into what happens when large volumes of highly illiquid assets start to come on to the marketplace. Not only can there be huge supply/demand issues that 'naturally' reduce prices, but the (ahem) genius of capitalism is that once other traders see a big position in distress, they can start actively pushing the market against that position, making the 'mark to market' losses worse hourly or daily, attempting to force the distressed player to cave in and do a fire sake at any price -- a game of financial chicken with billions to be won, and lost.

It's a jungle out there.

Posted by: Ethan Stock on November 9, 2007 at 5:55 PM | PERMALINK

The experts are at http://calculatedrisk.blogspot.com/ .

Why not shoot them an email?

Posted by: Measure for Measure on November 9, 2007 at 5:59 PM | PERMALINK

measure for measure, just so you realize, tanta (who posted at 4:21) is 1/2 of calculated risk, so she's already responded....

Posted by: howard on November 9, 2007 at 6:28 PM | PERMALINK
There is a maxim in Sociology, "What is believed to be real, is real in it's consequences."

Indeed, but I think there is something particularly special about the perception of value in the market, because the real consequences of beliefs about market value are, themselves, the essence of market value. The worth of a marketed good is simply what people in the market believe it to be worth. Inherent traits may effect that perception strongly at times, but the perception of value is value.

This is a little different than the usual context of the maxim as I've encountered it elsewhere; which is mostly that perceptions have their own set of distinct and very real effects independent of the accuracy of the perception, and independent of the effects of the thing that the perception concerns. So, for instance, widespread discrimination in a society against a minority group has real effects, as does the perception of the such discrimination. If the perception existed without the underlying reality, the real effects of the perception would remain despite the perception being false; and if the actual discrimination existed but it wasn't perceived as such, the real effects of the discrimination would likewise remain, but the effects of the perception of discrimination would not.

This is a little different, because the perception is inseparable from the reality, not because some intrinsic reality of value will always produce an perception of value, but that the actual present value will always be a product of the aggregate of perceptions about value.

Posted by: cmdicely on November 9, 2007 at 6:49 PM | PERMALINK

Measure for Measure: "Why not shoot them an email?"

Maybe because Tanta already commented, above. :)

Posted by: hilzoy on November 9, 2007 at 7:27 PM | PERMALINK

cmdicely: I think political power works the same way, doesn't it? For example, if people believe Karl Rove is influential and important, then he is; once they don't, he's not. At least this is one of the things I took away from reading Machiavelli.

Posted by: Ted on November 9, 2007 at 8:02 PM | PERMALINK

something particularly special about the perception of value in the market, because the real consequences of beliefs about market value are, themselves, the essence of market value. The worth of a marketed good is simply what people in the market believe it to be worth.

Mark Lasry might see it that way about some things, but that's the strangest thing I've read from you. Which market do you mean? Currency, art, collectibles? Stocks or bonds? Because if you mean the last two, purchases are made on more than perception.
If you mean CDOs, especially the sub-prime ones, the belief or perception was that no-money-down mortgages were going to behave like other low credit score loans. The belief, embodied in the model of that repayment behavior, was that credit card or automobile loans or trailer purchases were analogous in performance. Mortgages, even to low (or no) credit score purchasers would act like other bundles even in default.

The factor that is unseen, of course, is that there are market participants who don't buy the story or the credit or the assumptions. Those players are in the market, too. They just weren't buyers. Does that mean the marketed good is worthless?

The worth is the worth? You really lost me on that one. A good in the market is worth what the market participants think it's worth? Well, yeah, and....?

Posted by: TJM on November 9, 2007 at 8:10 PM | PERMALINK

Kevin wrote:
"It's certainly true that if no one is confident about how to value these instruments the market for commerical paper freezes up, causing the broader financial markets to freeze up in turn."

I don't understand. It makes sense to me that it would be more difficult to borrow money to buy instruments that, as it turns out, one does not know how to value. But how does this spread to the broader financial markets?

Posted by: Tom on November 10, 2007 at 8:53 AM | PERMALINK

Fruitcake Economics:

"The long world boom, driven by cheap money and resulting in high commodity prices, has had one overwhelming disadvantage: it has empowered a series of economic fruitcakes - national leaders and private sector investors who operate on principles that make no economic sense." - Martin Huchinson

Watch out below:

Scott Reamer: Bull markets create wealth and bear markets concentrate wealth.

Translation: Bull markets create huge pools of imaginary wealth and 'greater fool' jive capital suckers. When they crash the REAL MONEY picks up all the shattered remains at fire sale prices.

aka: First Law of Cartoon Physics: Any body suspended in space will remain in space until made aware of its situation.

The taxpayer, of course, the 'little people' who actually have to pony up, gets the bills coming and going.

Posted by: MsNThrope on November 10, 2007 at 10:28 AM | PERMALINK

See Daniel Gross at Slate for the real story of that asinine David brooks column.

Spoiler alert: Gasbag know-nothing decides to try to bitch slap Paul Krugman.

“The most powerful force in the universe is compound interest” - Albert Einstein

Posted by: MsNThrope on November 10, 2007 at 10:37 AM | PERMALINK

Kevin: as a former bond portfolio manager I can can tell you that it might be hard even to evaluate the credit quality of the underlying unbundled assets. Many of them are most likely backed by residential mortgage loans, including "liar loans" where the borrower gets to state his income without providing documentation to the lender. So even if you could get the servicer to give up the confidential loan files, said files might have little useful detail in them.

Therefore if you dump the securities on the market, you might get a bid -- maybe one the seller might not care for -- or then again, you might not. Any sane buyer would have to put out only super low ball bids because the stuff is hard to evaluate and the buyer also has to factor in the possible cost of administering a high number of loan workouts. To be clear, a loan workout would entail close communication with distressed borrowers to decide which ones should get a break on their loan payments, and which distressed loans should go through foreclosure, which then entails the maintenance and marketing of the foreclosed property. This type of investing in "distressed" securities involves hands on management of the underlying assets (presumably though close work with a topnotch loan servicer) rather than just sitting back and clipping coupons. Few bond investors are equipped for this. That would also limit the number of buyers.

As Tanta says, the proceeds are all going to the senior noteholders until their claims are paid, only then will the juniors see a dime. As Tanta says, if the senior noteholders are running scared, it might well be that even they will lose at least a percentage of their investments. That may be what S&P sees now.

Posted by: Sunlight on November 11, 2007 at 9:51 AM | PERMALINK
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