A recent survey of the top 50 institutions indicates over $7 trillion in structured finance assets currently in limbo. Now we know why they don’t want to lend to one another, hence the 100bps cut in discount rate. Dan Taylor at Aberdeen asset mgmt indicates a 1% decline in national RE prices results in a 40% haircut in CDO collateral (CDO market approximately $2 trillion. Now go back and look at the top 8 institutions in the US and compare level 2/3 assets with shareholder equity-game over. The credit contraction has begun and asset prices should eventually follow.

Bill

I wish I had a simple answer, or any answer. I can only point to a couple of things that I think are contributing.

One is that market participants have every reason to divert attention from the structured finance problem. To the extent that hedge funds, institutional investors, and securities firms are still carrying these assets on their books at stale, and therefore almost certainly too high, values, they have an incentive to keep the game going as long as possible. They may genuinely believe that the Fed will cut rates deeply enough that if they defer the day of reckoning, they won’t have to realize much if any losses. And in fairness, if the stuff really isn’t trading, what price do you assign? This isn’t a trivial problem. (My sense, BTW, is that the investment banks aren’t carrying much of this paper except in in-house hedge funds. There were stories that suggested they lightened up on their trading inventory over the summer).

And no one seems to have the foggiest idea how much paper is problematic. It ought to be the case that the simpler structures (meaning traditional pass throughs and ABS that have reasonably homogeneous assets, like only residential mortgages) probably have been remarked (indeed, they may never have suffered from much illiquidity). But my sense is the CDOs are still a problem, and likely the CLOs as well (there my belief is that they would have trouble when the underlying assets are heterogeneous and thus very hard to model accurately).

The second problem relates to the first. The reason no one has any good information is that fixed income markets are over the counter. No centralized exchange, no centralized reporting. This makes it harder for both the media and regulators to know what is going on.

The financial media has always given proportionately more attention to the equity market. In the stone ages of finance, it was because stocks traded and bonds almost never did, so there was legitimately more to talk about in the stock market. And retail investors bought stocks and maybe held a few munis way back then.

This stock-centric approach continued when the financial media expanded in the 1990s. The doc com era made stocks exciting, so again the focus went there.

Now I think the issue with the media is partly habit per above, and partly the phenomenon of the drunk looking for his keys under the street light, because that’s where he can see best. It’s comparatively easy to report on the equity markets, difficult to report on fixed income. And for the most part, only the pros are interested anyhow.

We don’t give investment advice, and if you read this blog, we don’t see much reason for optimism. However, the best way to sum up this post is that old Wall Street expression, “don’t fight the tape.”