Floyd Norris: Candidate for Worst Mortgage Securitization, Ever

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I’m sure readers know of other super turkeys, but Floyd Norris in the New York Times did find a prime example of crappy paper. Note that he limited himself to securities, so CDOs were not candidates for this Hall of Shame award.

The Merrill deal was a pool of seconds (“piggybacks”). Moody’s noted that this type of loan was typically written off after serious delinquency, since they had little or no equity from the outset. Key terms of the Merrill deal per Norris:

Fewer than 30 percent of the loans were made to borrowers who provided full documentation of their income and assets. Many of the other borrowers probably lied about their income. Nearly all had borrowed the full appraised value of the home, either for the purchase or for refinancing, and it is possible that some appraisals were unreasonably high even before home prices began to fall.

One hates to say it, but so far, this sounds only-somewhat-worse-than-usual late subprime practice. But they we get to the doozy:

…the mortgages had rates averaging 11.2 percent. Yet investors who put up most of the money were willing to accept a floating rate of just 30 basis points — three-tenths of one percentage point — over the London interbank offered rate.

And this paper was sold institutionally….or at least some of it was. Remember, Merrill would up retaining the super senior tranches on later deals because it couldn’t find enough suckers takers. And yes, super senior means AAA.

Moody’s still rates this dreck as investment grade (barely), while Standard & Poor’s cut it to junk, and has now ceased publishing ratings on this and similar instruments.

The amazing thing about an issue like this is at a large institution, you can’t blame a deal like this on a rogue investment banker. A lot of people are involved in underwritings: the investment banking department, bond salesmen, traders, sometimes research. Pricing is a formal process. So this means a bunch of supposed professionals either got very high together or were subject to collective delusion.

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  1. Anonymous

    These are the same people/underwriters that are granted exemptions for prohibited actions by Department Of Labor, in regard to playing with credit enhancements for trillions of dollars in pension funds — and I assume they were all getting high in a collective hallucination brought about as a result of smoking a collusive pipe — which continues to be passed around by Big Chief Smokum Bernanke….

  2. Richard Kline

    . . . Collective delusion. Per Norris, 40% of the loans were from California, with large quantities also from Nevada (read Las Vegas), and Florida: regional concentration of risk, an issue airily waved off by the Securitizers, too. There was a smaller outfit in WA State, can’t recall their name, of the same ilk; they, too, stroked out on repurchase obligations while the industry still pushed their plague-bad paper downchannel.

  3. a

    I’m not sure I understand. It seems more likely that you have an instance of normal-structured-product practice. You create a structure and then you see how much money can be extracted from it by selling it onto clients. I imagine initially the “30” was the x which was set up or down based on client demand. *Then* after having several successful rounds of selling it onto clients at 30 and reaping the profits, the departments needed to keep going at this level to reach their profit targets. But unfortunately (and this is where it deviates from the normal storty) there were no more clients to stuff, so they had to stuff their own banks. Their team still made the profits (and they pulled down the bonuses), while the bank itself suffered.

  4. Anonymous

    It would seem that Michael Corleone’s strategy to move the racket money into legitimate businesses has succeeded. Apparently all the wise guy kids got ivy league MBA’s, too. Stay tuned for Godfather XIV.

  5. guy n. cognito

    so this is the garbage being swapped for treasuries at the FRB that we the people are now guaranteeing? sweet.

  6. Anonymous

    ☺☺”And this paper was sold institutionally….or at least some of it was.”

    This begs a host of questions.

    Who bought this stuff?

    On whose balance sheet is this toxic waste sitting now?

    The people who bought this stuff, were they spending their own money or other people’s money?

    Of all this toxic waste that was generated, how much did the banks sell and how much did they retain?

    If this stuff is sitting on the balance sheets of, let’s say pension funds, has it been written down yet?

    While I have seen reems and reems of articles about the portion of this stuff that is still sitting on banks’ balance sheets, I have seen nothing about who bought this stuff and the potential consequences to those purchasers.

    Why have we heard so little about the devastanting effect this toxic waste must have had to the people who bought it?

  7. gbasin

    It’s not really relevant what made up the pool because it was heavily overcollateralized, this kind of analysis is meaningless (although it sounds SHOCKING) without knowing the structure of the pool. Heck, at a certain level of overcollateralization I’m sure I’d buy it for +30

  8. Tom

    gbasin has the right end of the stick, this is one of the fundamental points of securitisation – if you have credit support, you should be able to achieve a specific level of probability of loss (e.g. AAA etc). The main problem is that the people making the investments were not doing to the proper work on the bonds they were buying, so the analysis had been outsourced to the agencies. “Unfortunately”, they were asleep at the wheel, so people have ended up owning a pile of crap. And in answer to someone’s question, I would bet that a lot of this deal ended up in ABS CDOs.

  9. Anonymous

    Re: “Why have we heard so little about the devastanting effect this toxic waste must have had to the people who bought it?”


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