We Bought A Toxic Asset; You Can Watch It Die | Hacker News Reader

We Bought A Toxic Asset; You Can Watch It Die

npr.org

142 pointsgcheong45 comments

Everyone is still mistaking why these bonds were/are 'toxic.' It isn't that no one wanted to buy them. It's that no one wanted to buy them for the price at which the banks needed to sell them to remain solvent.

The bonds were 'toxic' because if the banks sold any of them for their market value, the banks would have had to mark down the value of the bonds still on their books. That would have shown that the banks were insolvent. By not allowing a market value for the bonds to emerge, the banks could maintain the illusion that their assets were greater than their liabilities.

> By not allowing a market value for the bonds to emerge, the banks could maintain the illusion that their assets were greater than their liabilities.

Fixed that for you: By not allowing a market value for the bonds to emerge, the banks maintain the illusion that their assets are greater than their liabilities.

wmeredith removed the word "could".

You are implying there is no market for toxic assets right now. Demonstrably false.

And in any case that's a poor way of making an argument.

A common phrase on a trading floor: "there's no such thing as a bad bond -- only a bad price."

I agree about the murky definition of toxic: you're talking about mark to market, something all the banks refused to do, till the treasury + fed told them to start doing it, stat.

But this is just one part of it; certainly the balance sheets were all over the place (with most firms senior management unclear as to their end-day positions) - but it's just as valid to state that GS/JP's requests for greater collateral which took down Lehman's and AIG so fast, as was the short selling which SEC Chairman Cox failed to properly curb early enough. (the FSA protected some of the london banking sector against shorts which ended up helping them massively).

The truth is, it was a cascade of events, with a dozen or more senior players, all of whom could have changed things if took a different attitude.

Fuld (CEO, Lehman's) could have sold lehmans for more than it's worth now a handful of times, but held out for a bigger number (not because he was trying to self-enrich, but to make his staff richer: they all held stock and he was very much a company man);

Blankfein (CEO, GS) /Dimon (CEO, JP): could have given their trade partners (AIG, Lehman's) a break and not required them to post the majority of their capital reserve as collateral for their day-to-day;

Paulson, Bernanke et al: could have been less naive to think that the market would sort it out, and should have stood their ground and stepped in earlier with (ironically) less money, which would have facilitated liquidity sufficient to calm the market and let these banks deleverage the bad debt at a more acceptable pace;

Cox at the SEC: could have been less spineless.

Chris Flowers, Warren Buffet, others: could have been less picky and bought stuff, rather than requiring that the government go in with them on any deal they proposed without any backing or collateral.

etc etc.

there were (apparently) so many potential exit points for this thing, and well, the industry managed to grab defeat from the jaws of victory often - if only because it wasn't the 'right thing to do'.

a very good read for anyone who wants to get a good grasp of the timeline of all this is Aaron Ross Sorkin's Too Big To Fail. It's a rather fascinating expose into some of the inner meetings and conversations.

the tl;dr of it:

- everyone tried to buy/acquire/merge/whatever everyone else. Fuld literally tried to sell Lehman's to every single member of the big banks

- this thing could have been solved a half dozen times if it weren't for something quite simple/trivial

- it turns out that the UK Treasury eventually were the ones to crush the last minute save of Lehman's via Barclay's Capital. A deal was struck, ALL the big banks posted collateral to support Lehman's, and yet Darling at the British Treasury shut it down over a procedural issue in Barclays' company charter... (and, well, because the political reality is that the deal wasn't as good as it could be...)

I think the term toxic comes from the idea that you can be damaged by being in contact with one.

CDSs and CDOs are contracts that carry cash flows in both directions. When you sell a CDS you receive the premium, but if there is a credit event you have to pay out way more than the premium. If you sold one in the good times you'd now be stuck with a contact to payout a whole load of money an no way to sell it off.

For a CDO you have a similar upside and downside, but it's a bit more complex. You can be in the position where your cotract exposes you to alot of risk, and no matter how cheap you make it no one wants to buy it. That's a toxic asset.

CDOs are a bit trickier. If the issuing company held onto the lowest tranche then they were required to hold the debt and assets on-balance sheet and it was essentially a form of financing like any other. If they sold all the tranches, then they could keep the issuing fees and push all the debt and assets off-balance sheet. There usually was no recourse to the company for off-balance sheet CDOs, but there were some complicated and obscure exceptions.

I have a good story about this market. A friend of mine is doing this and he bought a $20M portfolio of bad boat loans for less than 1/2 cent on the dollar. He closes on the portfolio and the next day gets a call from a bank in Texas that has repossessed a boat in the portfolio and wants to know his address so they can ship it to him. He tells them to sell the boat ASAP and send him the proceeds. The boat sells for more than he paid for the entire portfolio. There is some gold in this muck.

One word of caution on this is that to collect mortgage payments you have to be licensed as a bank in that state and some states have hefty penalties for illegal collection if you aren't.

Right; these assets are "toxic" not so much because they are of low or perceived as having no value but because it's difficult to impossible to correctly price them.

If you hold them to maturity, you might make out pretty well.

A good story. You can listen to the whole thing on the planet money podcast:

http://www.npr.org/rss/podcast/podcast_detail.php?siteId=944...

That sounds like an interesting investment. Is there a way I as an individual can buy something like this?

Easy. Just buy a junk bond. A REIT maybe if you specifically want a building mortgage (as opposed to a company borrowing money).

But it's not a good idea unless you are very experienced (or have someone very experienced helping you).

Otherwise you're pretty much guaranteed to loose money.

Actually no broker will talk to you unless you are a "sophisticated investor", which is another way of saying "has a lot of money", but also you need to have been investing for at least a few years.

I have firsthand knowledge of this market. Unfortunately, it's very difficult to buy bonds like this for yourself if you are not an institutional investor.

there was some talk of selling toxic stuff from TARP participants to private investors. IIRC Blackrock and/or PIMCO were even supposed to construe ETFs that pretty much anyone in the world could buy. Unfortunately banks realized pretty soon that they themselves can make a lot of money by cherry picking and selling those assets, so financial lobby killed this effort quickly. That's my understanding anyway.

If that's so how did NPR go talk to this guy in Kansas and get one? They don't have a lot of money, and they aren't a bank. I bet this guy in Kansas is getting a lot of phone calls like this one.

It's not impossible, just hard. There's no exchange you can go to, and dealers will generally not work with you if you're a small fry.

In NPR's case, I'd say: (a) it looks like they worked directly with the seller, not with a bank/broker/dealer, and (b) their foundation has $250MM of assets, so they're not exactly a small fry (http://www.npr.org/about/statements/fy2008/fy08nprfoundation... [pdf]).

It sounded to me that they just went in on it with the guy from Kansas. They bought it for however much, and NPR chipped in $1000, which is why they say if they keep getting ~$140 monthly payments through to November, they'd break even.

penny stocks, for a similar risk/reward profile

If you have an account with a high end broker (e.g. the private wealth management division of an investment bank), they'll usually let you buy them. You have to meet a pretty high net worth threshold to open that sort of account though.

SecondMarket is one of those.

The 'interactive' portion is a very cool display of data. You can view the history of the asset over time (the asset looks like it was originally created in december 2006). Over time, a large number of houses in the asset go delinquent, and then bankrupt.

It lets you experience, from a distance, the panic that the original investors must have felt as they saw their hopes for the asset melt away.

I also like it because you can see it going south long before 2008, which is when economic panic started going public.

I just can't understand how there isn't fraud involved here. If someone claims that they have a mortgage back security that was worth $2.7 million, and is now worth $36,000, that is 1.3c on the dollar. I just can't believe that these things are backed by real houses. I don't understand how any house, no matter how overinflated, could be worth so little. Even houses purchased in the worst bubble market, foreclosed on, where the previous owners punched holes in the sheet rock on the way out, and sold at auction, shouldn on average be worth only $36,000 now. There must have been fraud about what is actually backing these securities.

You're confusing worth with price. $36,000 is what someone was willing to sell it to them for. The main buyer obviously thinks it's worth more, although maybe not a whole lot, he was searching for something particularly distressed so that the NPR people could with only $1000 buy a non-minuscule fraction. What it's worth when it's held to maturity is another thing, something the NPR crew will be finding out in due course.

Don't insist on malice when incompetence is a possibility. There were honest and/or stupid mistakes made. The biggest was assuming that the general upward march of residential real estate prices would continue, which wasn't entirely insane on its face.

Collateralized debts are sold in tranches: One guy gets the first 50% of the money, the next guy gets the next 20%, the next gets the next 20%, and the final sucker gets his share back only after the other 90% has all been paid off. (Actually, it's a bit more complicated than this, but you get the idea.)

Even with a 50% drop in market prices, the guy with the "senior" tranche is happy; he's getting his money back. The guy with the last 10% was never expecting to get all of his money back, so while he's disappointed about being completely wiped out, he's not altogether shocked.

The collateralized debt crisis is basically all about those people in the middle -- the 50%-90% range. They thought their money was safe (they couldn't imaging the market dropping by more than 10%) and they paid a correspondingly high price as a result (i.e., they didn't get much of a discount vs. the face value of the debts), but it turns out that they're taking some of the losses too.

Sounds like a pyramid scheme to me.

More about pricing risk. Everyone can choose how much risk they're willing to take.

That's not how it works. What happens is a bunch of mortgages of varying quality get thrown into a pool. The pool is then sliced up into a bunch of different investment vehicles. The lowest risk (and lowest return) investments get paid off first, and the highest risk (and highest return) investments get paid off last.

The 2.7m -> 36k transition is on one of the higher-risk portions of the pool. The investor who paid in 2.7m basically bet that there would be plenty of money left over after the low-risk betters below him got paid off. He was wrong.

The total value of the total pool probably only went down by 30% or so, but that's enough to completely wipe out the highest-risk level investor. Add on the fact that they were probably leveraged to get into the position in the first place, and now you understand why 2008 was a major clusterfuck.

Price is what you pay. Value is what you get.

Further to what cperciva and jfager said, this bit stands out: At some point those homes will be taken over and sold for a loss. Every time that happens, the bond shrinks. Eventually, our part of the bond will disappear entirely. Until then, we get a little money every month from people paying off their mortgages. We just got a check for $141.

It sounds like the guy knows he won't get any money if the underlying assets are sold, so their value doesn't really matter. He only gets paid when people pay their mortgages.

Does it mean that it doesn't make any difference for those people if they pay their mortgages or not? The houses will be taken over anyways... does it really make a big difference at this point?

It's actually beneficial to the investors if they keep paying their mortgages; they certainly won't foreclose an a home unless necessary. So yes, it matters.

By the way, didn't you see the "paid off" portion of their portfolio? It's quite big.

Quick! Find out which mortgages are part of the NPR bond. Make sure to pay them so they write a good news story and the whole country thinks things are great.

In other words, I'd rather look at the market as a whole not just a tiny piece of it.

I think this is pretty obviously an investigative human interest story, not an economics piece.

People aren't good at understanding big numbers. Slicing off a small part of the mortgage crisis and providing a detailed history of that small part makes it much easier for people to understand what's going on.

It's just like unemployment rates -- saying "ten million people are out of work" doesn't mean as much to most people as "one of your ten closest friends is out of work".

And what happens if your little piece acts totally different than the rest of the market?

Then you write "we were lucky, and most investments did much worse than this". But it looks like the slice involve here is large enough that it will probably do a good job of illustrating things.

They are not clearly highlighting the problem, which is why you think your skepticism is warranted. You have to look at it like this: we are talking about an investment that was initially worth $2.7 million and that now yields monthly payments of 36$140. That investment has obviously lost a lot of value: real* value, because it will never yield larger monthly payments than it does now and will probably lose more value.

So, show of hands signal to noise ratio on HN dropped significantly recently? Seeing a lot of content free articles.

yeah

nope

I gave you three downvotes for a blatant attempt at karma whoring, but thanks for playing.

actually that didn't even occur to me until just now.

Complaining about noise and conducting straw polls about noise are also noise.

Many of us watched the same thing happen to reddit.

Re-read Shirky's classic talk on the topic http://www.shirky.com/writings/group_enemy.html

good article. made me realize I should just remove HN from my feed. see you guys.

I never read this before. Great read. Thanks for the link man.

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