Wednesday, June 20, 2007

Unwinding of mortgage backed securities positions

Bloomberg is reporting in "Bear Stearns's Attempt to Save Hedge Funds May Falter" this morning that "creditor Merrill Lynch & Co. decided to seize and sell $800 million of bonds held as collateral for loans to the funds"...referring to a couple of funds in trouble due to bad mortage loans...the bigger issue is as Greg Newton describes it here that "what happens when the whole world reprices its CDO and RMBS (residential mortgage-backed securities) [on the] basis [of] forced liquidation"...other commenters raise the same issue, specifically in the Bloomberg article of this morning as follows:
"The real fear has to do with just how many other funds and warehouses could be in trouble,'' said Jeremy Shor, who oversees about $3 billion in asset-backed bonds as a portfolio manager at Brown Brothers Harriman & Co. in New York", and " Asset sales could force the banks to reduce the value of their own investments and loans they made to other funds, said Josh Rosner, managing director at New York-based investment- research firm Graham Fisher & Co."...
The Bloomberg piece also states that
"As defaults rise, bondholders stand to lose as much as $75 billion subprime-mortgage securities, according to an April estimate from Pacific Investment Management Co., manager of the world's largest bond fund. Investors in all mortgage bonds will probably take about $100 billion in losses, according to a March report from Citigroup Inc. bond analysts"...
Also referenced is the bailout "of Long-Term Capital Management LP, which lost $4.6 billion, in 1998, he said. At the time, lenders met and agreed to slowly liquidate the fund's assets to limit the impact of its collapse"...a quick unwinding at any time would likely result in greater repricing to the downside than a more measured, gradual recognition that the mortgage-backed securities and associated derivatives are worth far less than what the owners have them valued on their books currently. Recognizing the $100 billion in losses mentioned above in a short time period would likely cause a lot of fear-driven market activity that might be avoided by the more measured workout.

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