“After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear”

Investors are free to completely write off the CDO of ABS holdings themselves in their capital calculations if they want a worst case scenario. The holders are finally giving enough disclosure to allow that. I fail to see how actually liquidating the entire sector in the middle of a financial and economic crisis and guaranteeing a worst case scenario helps things. It certainly doesn’t make things clearer in any meaningful sense.

This FT piece seems to be talking about what we call CMOs — Collateralized Mortgage Obligations. What we call CDOs tend to be diversified (eg, all the CDOs I worked on this decade had no more than 5% mortgage assets). This article is not talking about them.

A CMO goes into technical default if ANY of its tranches eg fail to meet an interest payment. Thus a AAA tranche can be in default even if it’s still getting its interest every quarter.

As for the miserable liquidation return reported. If a CMO gets unwound, that means you crack open the s-f shell and sell the assets inside. In this case, mortgage bonds (MBS — mortgage ABS).

But the market for same has been zero during the crisis. Thus anyone unfortunate enough to liquidate a CMO during the crisis is going to get very little when he goes to sell the MBS inside — regardless of how the MBS are themselves performing.

All of this to my eye tends to mitigate the horror of the headline to this story. Not that the world is not horrible.

The great error during this time is to liquidate the mortgage assets in a non-existent market. Compulsions to do so can come from various sources. Lucky are the holders who are able either by the terms of their agreements or negotiation to re-write the instruments to allow the portfolio managers to hold on.

At bottom the question is — how are the mortgages performing? And then: how are the MBS (composed of mortgages) performing? Only then can one evaluate, really, the state of affairs at to CMO (composed ob MBS) performance.

Still — the numerical tidbits in the article are worth filing.

Accurate data on true performance is generally closely held by the holders. No different that the daily price of porgies among the various players at the Fulton Fish Market.

Nothing will be fixed until the ratings agencies get tar heeled. Auditors too. You can’t have a clean system run by dirty players.

I think this means we’re finally done with screwball schemes to transfer this stuff to Uncle Sam in exchange for actual money. Like come on.

I would also suggest a AAAA rating and an AAAAA (no we really mean it this time) for investments that are actually safe, now that AAA has been so debased.

Costs associated with foreclosure, legal fees, back taxes, neglect, vandalism, fraud in pricing, zombie neighborhoods, no buyers, no financing for new buyers, no bottom in sight, cheap rentals, etc.

A good link.

CDO is not all what it appears to be. It can have a credit default swap sold out of it (making it a synthetic CDO) for instance. In some cases the higher rated portions were made up of large chunks of agglomerated left overs that had no takers. Through a second tranching of the junk, they were able to turn some of the junk into a higher grade product (take the top of the income stream of a bunch of Bs and get some As out of it. The idea being that not all of the lower tranche mortgage bonds will go belly up because “of course” they act independently of each other.