"S&P Says Mortgage Freeze Plan May Cause Downgrades"


Note how, nevertheless, S&P bends over backwards to look supportive….

From Bloomberg:

U.S. Treasury Secretary Henry Paulson’s plan to freeze some subprime mortgage rates in an effort to stop a wave of foreclosures may lead to ratings cuts on some mortgage bonds, Standard & Poor’s said.

“Simply freezing interest rates on some U.S. first-lien subprime mortgage loans would have a negative impact” on ratings of some residential mortgage-backed securities, analysts at New York-based S&P wrote in a report today. S&P said modifications to the loans will mean reduced payments available to investors from creditworthy borrowers…

The U.S. plan may “help stabilize mortgage default rates and mitigate the risk of future downgrades of highly rated tranches,” said Glenn Costello, a managing director in the residential mortgage-backed securities group at Fitch Ratings in New York. “However, the implications for the lower-rated tranches of these transactions are unclear at this time.”

S&P, the largest ratings company, said bondholders may benefit from mortgage modifications if they result in fewer foreclosures….

“In certain instances, the negative effects may outweigh the positive benefits,” S&P said….

Interfludity discussed possible price (as opposed to ratings) impact earlier this week:

Suppose it is true that, on-average, cashflows to the whole class of affected securities changes very little under the workout, that the savings to investors from avoiding defaults roughly balances the cost of the reduced income stream. Consider what this workout does to the certainty of cashflows for any particular MBS pool. Prior to the workout, under a low-default scenario cashflows are very high, while under a high default scenario they are very low. In the “good case”, the senior tranches get paid, but so do the tranches a few levels down. In the bad case, the junior tranches lose everything, and the senior tranches lose some fraction of their value. For valuation purposes, the marginal junior tranches now resemble at-the-money call options, valuable when outcomes are volatile, worthless when they are certain.

And what would the Bair/Paulson plan do? It would increase the certainty of the cash flows, to a level where, on average, senior tranches would be made whole, but marginal tranches would lose out. In other words, even if the effect on total cashflows in the aggregate is very small, the Paulson plan would wipe out the option value of tranches at the margin. Holders of these tranches won’t take a 5% haircut, but a 100% haircut off the tranch’s current value. You betcha they’ll sue if they have any hope of relief. [*]

On the other hand, holders of senior debt will be made whole with much greater certainty. The proposal effectively represents a transfer of wealth from junior to senior trancheholders. Which gets us to its clever systemic implications.

The current credit crunch stems not from the absolute scale of writedowns, but from the distribution of the losses. Highly leveraged entities with very little capacity to bear risk, who thought they were holding “supersenior” (but yield enhanced!) securities, are facing catastrophic unexpected losses. If those losses could be shifted to investors with a greater capacity to bear risk, the systemic implications would diminish towards the absolute scale of the losses, that is, towards insignificance.

Less senior trancheholders are being asked to take a hit, because they can, to save other investors who can’t afford their losses. From each according to his ability, to each according to his need. You’ve gotta love capitalism.

The observation about saving top-rated paper is clever, but I doubt that this crowd got much further than crafting a plan that would have minimal negative impact on investors (a point Tanta at Calculated Risk made yesterday) so as to minimize objections (the side effect of minimizing impact is of no consequence….).

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  1. Anonymous

    At this point, finding honesty or ethics in this subprime situation is like thinking there is a chance of the mob putting a stop to casino betting (and rating-like prostitution); its a done deal that the mob is in control.

  2. Anonymous

    The American Securitization Forum wrote the rate freeze presented to the public by the President of the United States of America.

    I found it on their website americansecuritization.com.

    It would appear that some of the firms that sold a lot of the bad debt, are members of the industry group that authored the plan with which they will try to bail themselves out.

    Members include Countrywide Home Loans, Ameriquest Mortgage Company, Capital One, Citi Global Markets Inc., Fannie Mae, Freddie Mac, GMAC, JPMorgan Chase, Thornburg Mortgage, Inc., Washington Mutual Bank, MetLife

    DBRS, Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s

    ABN AMRO, Inc., Banc of America Securities LLC, Barclays Capital Inc., Bear, Stearns & Co. Inc., Countrywide Securities, Credit Suisse, Deutsche Bank Securities Inc., Goldman, Sachs & Co., HSBC Securities (USA) Inc., Lehman Brothers Inc., Merrill Lynch & Co., Morgan Stanley, UBS Investment Bank, PIMCO,

    Should Secretary Paulson have disclosed the conflict of interest?

    Who is going to profit from the rate freeze modifications?

    Who is going to look good if it works, but very bad if it doesn’t?

    It looks like the executive summary of Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, says they’re not going to check homeowner income, and will be allowed to modify loans even if they don’t make contact with the homeowner.


    Who’s stocks went up after the announcement?

    CHAIR Greg MedcrafT, Managing Director, Global Head of Securitization,
    Societe Generale Corporate & Investment Banking DEputy CHAIR DianE W old, Managing Director, HEAD OF Investment Banking, GMAC-ResCap
    SECRETARY Sanjeev Handa, Head of global public markets, TIAA -CREF

  3. Yves Smith

    Anon of 8:20 PM,

    I haven’t had a chance to read the text of the two speeches, and didn’t want to post anything until I had gone through them and also (at a minimum) looked at the American CoreLogic study (which gives a very granular breakdown of resets; some press stories indicated the designers of this plan used that data) before I did a proper post on it. So thanks for the link and the heads up.

    I am gobsmacked at what you wrote, and can’t believe it’s legal. How can you change a contract, particular one involving a deed (remember, these puppies have to be filed at the local courthouse) and not have the counterparty sign off? That doesn’t sound permissible. I suppose they could treat the reset as a right that they are waiving, but I think even waivers have to be acknowledged (signed) by the counterparty.

    The other bit that is astounding is not verifying income. So they are going to decide who can afford a mod without verification? This creates massive incentives to lie. Per the point Tanta has made eloquently, several times, about no doc loans, this enables lenders to be irresponsible AND be able to characterize it as borrower fraud! Staggering.

    This proposal is serious, all right. It;s a serious mess. Expect litigation.

  4. Anonymous

    The Asset Managers Forum is an affiliate of The Securities Industry and Financial Markets Association
    © 1998-2007 The Asset Managers Forum | 360 Madison Avenue, New York, NY 10017-7111 | p: 646-637-9200 | f: 646-637-9118

    President Bush Signs Pension Reform Act
    The Asset Managers Division is pleased to report that President George Bush signed the Pension Reform Act which modernizes the Employee Retirement Security Income Act (ERISA). Of particular note, the new pension legislation includes a prohibited transaction exemption for cross-trading between separate pension accounts held with the same money manager and boosts the level of ERISA assets that can be invested in investment vehicles such as hedge funds. Association staff, in conjunction with AMD leadership and its members, worked closely with Congress on this part of the legislation.

    The Securities Industry and Financial Markets Association(SIFMA) represents the industry which powers the global economy.

    Born of the merger between The Securities Industry Association and The Bond Market Association, SIFMA is the single powerful voice for strengthening markets and supporting investors — the world over.

    Our dynamic, new organization is passionately dedicated to representing more than 650 member firms of all sizes, in all financial markets in the U.S. and around the world. We are committed to enhancing the public’s trust and confidence in the markets, delivering an efficient, enhanced member network of access and forward-looking services, as well as premiere educational resources for the professionals in our industry and the investors whom they serve.

  5. Kevin

    What happens to CDS holders which insured say the junior tranches that are going to be adversely affected by this plan? I’d imagine that’s also going to be a problem…good for the lawyers I guess, eh?

  6. Yves Smith

    Anon of 10:10 PM,

    Agreed. While I respect Tanta, I think she has read the statements in too literalminded a fashion (in terms of her conclusion there won’t be much basis for filing suit), and I intend to get to this later in a post. Even I can think of grounds for a suit (I’ve already reviewed it with an attorney who gave it a thumbs up) and if I can do that without the benefit of having the servicing agreements to read, I am sure clever attorneys can come up with tons better grounds for litigation.

    The question is whether any investors feel that they have been or potentially will be damaged enough for it to be worth their while to sue. Levered players like CDS market participants might be one camp.

    I’ll go over this in more detail in a post I will be getting out (likely the wee a.m. at the rate I am going).

    Anon of 10:13 PM,

    Thanks for pointing them out. I actually saw them this am and wanted to use them somehow, they are great charts.

  7. scotty

    In his own words, Mr Roubini said, “Losses due to subprime alone will be as high as $400 to $500 billion and this does not count losses due to near prime, prime mortgages, auto loans, credit cards, commercial real estate, leveraged loans, loans to the corporate system; if added all up losses could end up – in a US recession – as being as high as $1,000 billion or $1 trillion. The financial bloodbath thus has only started and a hard landing of the economy is clearly ahead of us.”

    A trillion? It used to be that a trillion was a lot of money, but my eyes opened when I saw the Opednews.com article by Sharon Kayser, titled, “Hey Buddy, Can You Spare $1,000 Trillion?”

    Instantly, I knew that someone had erred! A thousand trillions? Hahaha! What a preposterous number!

    So I was instantly on the phone to call Ms Kayser so I could tell her that there has been an error in the title, and then maybe, you know, she could drop a line to my boss and tell her what a nice guy I am and how firing me right before Christmas is so tacky, no matter how well-deserved, or maybe she could get me a job there with her or something.

    So imagine my horror when I learned that there was no error! We are talking about a quadrillion freaking dollars! Instantly I knew that she was doing that on purpose to give me a heart attack!

    The actual excerpt is that “there is currently at least a $1,000 trillion black hole in the world economy”, what with “$600 trillion in world liabilities, plus more than a $400 trillion derivatives neutron bomb, all of which will go off when the Westerners (from EU and US) will no longer be able to borrow.”

    So, with trembling hands I feverishly punched the calculator, adding 400 trillion plus 600 trillion, which is 400,000,000,000,000 and 600,000,000,000,000, and then I think, “That’s too many zeroes! It won’t even fit on my calculator screen, for God’s sake!”

    So I do it by hand, and it keeps coming out as “1,000,000,000,000,000”, and it looks so weird that I knew it has to be wrong. It can’t have that many zeroes in it!

    So, I go to the dictionary and look up “quadrillion”, and it says that it is “a one followed by fifteen zeroes”. Except in Britain, where it is 24 zeroes, for some reason.

    Anyway, it really IS written out as $1,000,000,000,000,000!

    That number must have stunned me into insensibility, as the next thing I knew, it was later in the day, things were coming into focus, people are yelling at me to wake up and get back to work, and asking when I am going to do a little work around here, and how about getting a little work done? Naturally I responded to their inquiries by yelling obscenities and spitting on them, when right in the middle of the discussion about my work habits, here comes Ms Kayser again, saying, “Talking of jobs, did you know that in 1972, wages reached their peak? Today, real wages are nearly one-fifth lower – inflation adjusted!”


  8. scotty

    The subprime/muni-meltdown/SIV-bailout/derivative “situation” related to many of these day-to-day stories, reminds me to think globally but to act locally, i.e., this bank bailout is said to not be a taxpayer related issue, but Paulsons plan may be linked to restructuring muni bonds, thus The Fed most likely is going to rely on “local” taxpayers to shoulder the burden for “local” infrastructure costs that wont receive future Fed infusions. Thats a theory, but linking bank debt to munis reminds me of the fact that as the housing bubble was pumped and inflated, local taxes increased due obviously to increasing property values! The increased local taxes have placed less burden on The Fed, which IMHO is being drained by Iraq..ok, its a weird theory, but I like it….to wit:

    On Tuesday, State Board of Administration trustees — Gov. Charlie Crist, Attorney General Bill McCollum and Chief Financial Officer Alex Sink — voted to hire New York-based firm BlackRock to manage the fund. It will split the $14 billion pool into two funds — one with $12 billion in investments deemed safe and the rest of the money into mostly mortgage-backed notes. BlackRock said that by Thursday, local governments could start withdrawing a portion of their funds.

    Despite the restructuring, many finance officials, like Boop, were not convinced.

    Leesburg does not plan to invest any more money in the newly restructured fund in the near future, Boop said. He said it’s probably wiser to invest the city’s money in more secure investment funds.

    “I think we’re seeing the tip of the iceberg,” he said regarding the sub-prime mortgage meltdown and signs of a possible recession in 2008.

    The city, however, did keep $100 in the fund to “keep the account open” in case Leesburg plans to invest it in the future, Boop said.

    “We did it to be prudent,” Boop said about the city’s withdrawal.

    Leesburg has temporarily invested the money in a SunTrust account that earns about 4 percent annual interest.

    “The most important thing is that we’ve taken the necessary action to protect our taxpayers’ money,” Boop said.

    Lake County withdrew $144 million last Thursday but reserved $1,000 to keep the account open, according to Barbara Lehman, chief deputy clerk for the county finance department.

    Even with Tuesday’s restructuring “we don’t have any plans [to reinvest in the fund] until we see how the fund will be handled,” Lehman said. “I’d like to see some guarantee from the state that we would get back 100 percent of our assets.”

    Meanwhile, the money Lake withdrew from the State Board of Administration fund is sitting in an account at Wachovia bank until the county decides how to reinvest it.

    Groveland has about $9.3 million invested in the fund. Most of that money is used to pay for infrastructure projects and debt payments on bonds that are not due until late next year, said Dolly Miller, the city’s finance director. Miller does not see the state’s limiting withdrawal as a problem because the city has enough money invested elsewhere to cover operational expenses such as salaries.

    “However, it is a concern that it is taxpayers’ money and we will eventually need that money [in the State Board of Administration fund] for the various projects that are coming down the pipeline,” she said.

    Lori Houghton, finance director for Tavares, said the city has about $8.9 million in the fund. Like Groveland, most of the money is reserve funds used to pay for long- term projects.

    “At this point, it’s not a concern,” she said.

    However, once the state starts allowing withdrawals, Houghton said the city will pull out as much as is allowed and invest it elsewhere.

  9. a

    “…Most of that money is used to pay for infrastructure projects and debt payments on bonds that are not due until late next year…”

    Maybe I woke up cynical today, but this wouldn’t be a case of borrowing in the municipal market (using the tax-free advantage to get a good rate) and then lending it to the state fund to earn money “risk-free”? And then crying when it blows up? Probably not, but it’s early in the morning…

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