By Thomas Adams, an attorney and former monoline executive, and Yves Smith
Our accompanying post at Naked Capitalism describes, at a high level of abstraction, a data compilation and analysis that shows that a substantial majority of the transactions in Maiden Lane III are in the public domain. These transactions have long been a focus of controversy. When the Fed arranged for AIG to pay out 100% on credit default swaps with bank counterparties, part of that payment came through the sale of the underlying CDOs to Maiden Lane III (yes, that’s a simplification, see here for details). Moreover, the redactions from AIG’s SEC filings tried to keep these same transactions secret.
As that article describes, this analysis is significant because the Fed has claimed the Maiden Lane III transaction-level information is confidential, when as we demonstrate, substantial transaction level detail about AIG’s CDOs is already public, and the gaps can be identified and may be able to be filled in via other sources.
We discuss in more detail here the information we have developed on these deals.
We have put a model summary and detail from a subset of transactions on Scrib ID. This information provides insight into the Maiden Lane CDO portfolio, on issues such as vintages, collateral types, deal managers, bankers and counterparties, that previously could only be surmised from partial disclosures. The detail also shows how much can be gleaned from public sources and and illustrates vividly how bogus the Fed’s call for secrecy is.
Note this model is “confirmed data only” where all items come from public sources. We have a second model, where we make reasonable extrapolations (for instance, there is no public source data for par values on CP, or commercial paper “classes”, meaning tranches, but they can be computed readily. Par values for CP classes (8 transactions in total) and Goldman Sachs Abacus deals (its synthetic CDO program) are the main gaps in transaction level detail in the “confirmed data only” spreadsheet.
The AIG memo identifies $66 billion in par value in “multi sector” CDOs held by 9 counterparties, which consisted mainly of so-called “high grade” ABS CDOs, which had AA and A tranches of subprime bonds as a major constituent (the rest were “mezz” CDOs). Despite the name, high grade CDOs have on the whole not fared much better than so-called “mezz” CDOs, due to the fact that high grades were more CDO-squared like than “mezz” (they frequently contained 15% to, in the last gasps of the bubble era, as much as 40% of “inner”, meaning AA or lower CDO tranches). The other constituent elements of a high-grade CDO were generally worse than the non-subprime parts of a “mezz” CDO, since they were mainly seen as providing more diversification, while for a “mezz” deal (which consisted heavily of BBB subprime tranches), some better-quality instruments were included to improve credit strength.
The $66 billion is more than the amount of principal value of high-grade and mezz CDOs that went into Maiden Lane III. The total principal amount was $62.1 billion, and of that, roughly $10.8 billion was commercial real estate CDOs (see p. 3, we believe the missing par value can be extrapolated). That would leave $51.3 billion in high grade and “mezz” CDOs. While some of the oldest CDOs could have terminated between November 2007 and the time of the rescue, the bulk, probably all, of the difference is due to selection: the worst CDOs went to Maiden Lane III, the rest presumably are at AIG. This idea is confirmed by the ratings. As we showed earlier this week, virtually all of the high-grade CDOs had been downgraded to BB+ or lower (and although we have yet to add current ratings to the spreadsheet, so far most of the ones we have found are CCC or DDD, total washouts), which confirms the notion that the strongest ones are at AIG. The notion that some CDOs were kept at AIG is also confirmed by the fact that the Fed disclosed that the Maiden Lane III ABS CDO payouts were made on a portfolio of ABS CDO exposures whose size was larger than the par value of the Maiden Lane facility.
We have a second model, with information that builds on the initial model by adding extrapolated or derived information. In that model, we have also estimated the current value of each transaction, using the ABX index and constructing implied portfolios by year of issue and type of CDO, and using a subprime index, the ABX, as a guide. While the ABX is not a perfect proxy for the value of the underlying collateral, it is the most transparent indicator available today and it is widely used as a tool to estimate mortgage and CDO deal values. We tested this approach by applying it to the transactions at a date we thought would represent when marks were made for the AIG memo, and it delivered prices pretty close to those AIG and its counterparties used. A professional who is currently valuing CDOs also reviewed the methodology and results. Again, this confirms how much can be gleaned from information in the public domain.
This analysis still has some anomalies and gaps:
Our information is based on par at origination. Some of the exposures, especially for the older transactions, may have amortized since closing, although this amortization would be slowed by the mechanics of principal lock out for subordinated bonds in MBS transactions.
We have not included the commercial real estate CDO transactions yet. This is a comparatively small portion of the entire portfolio. The bulk of the value is in two large transactions (identified) that total $7.5 billion of par value. It appears tht the par value of the “other” CRE CDOs can be extrapolated and is roughly $3 billion of par value of commercial real estate CDOs.
Deutsche Bank is listed as a counterparty on only $600 million of ABS CDOs under discussion in November 2007, yet received payment of over $6 billion from the Maiden Lane transaction. Perhaps this is because Deutsche Bank was a counterparty on many of the CRE CDOs. If this is correct, this strongly implies that the $3 billion of “other” CRE CDOs mentioned immediately above are the only transactions in this portfolio that have not been identified.
The AIG memo indicates $5.2 billion of exposure to individually identified Abacus deals but publicly available information on these deals appears to indicate a smaller amount of total issued par, potentially indicating incomplete information in the AIG memo. The Abacus deals were sponsored by Goldman, though some used other third party deal managers.
The AIG memo also does not mention the total amount of collateral calls for the Société Générale counterparty exposure, whereas this amount is listed for all of the other counterparties. The collateral calls also appear to be a smaller amount than the marks (after taking into account the thresholds) would indicate. Put another way, based on the marks, the collateral calls should have been larger than they were, in aggregate and by counterparty, than they were described in the AIG.
As discussed in the AIG memo, the marks provided by the counterparties ranged widely, even for similar transactions. While the Goldman marks appear to be the most aggressive, other counterparties seemingly lobbed in softball marks of close to 100% even on 2006 mezzanine deals, which were likely to be in distress by late 2007. For example, for 2006 mezzanine deals, the counterparty provided marks ranged from 55% to 100%. Generally, the marks provided for the mezzanine deals were generous, in light of serious deterioration in the underlying collateral by that time. As a result, the discrepancies between our implied marks and the counterparty provided marks are the greatest for the mezzanine deals.
Certain of the insured classes had multiple counterparties, thus obscuring our ability to calculate the exposure by counterparty. Allocation within a class to multiple counterparties is not disclosed publicly.
The data also highlights the distribution of the transactions across deal managers or advisors. Trust Company of the West, TCW, was the deal manager for over $10 billion of AIG’s exposures, over twice the next largest deal manager. The concentration of deals from the top managers highlights the cozy relationships AIG had with these managers and, to a degree, the consequences of such concentrations.
Very little information was available on the Abacus deals in contrast to the other transactions (and even in contrast to information on other Abacus deals).
While our information on the lead bankers for the transactions is not as complete as we would like, it does provide some insight into other interesting relationships in the portfolio. Frequently, the bank which underwrote the transaction would end up as the counterparty with AIG. However, in many cases, other banks would be the counterparty, which provides clues on the interconnections in the CDO market and the lack of distribution for this product. Even when a lead bank found a third party purchaser for the CDO, it wound up being one of a small list of banks already participating in AIG’s transactions. Some banks, such as Merrill and Goldman, were frequent sellers and buyers of the AIG insured bonds.
We also want to challenge the Fed’s oft-touted notion that it is necessary to keep transaction-level detail in the Fed’s various special bailout vehicles (Maiden Lane I, the Bear Stearns vehicle, Maiden Lane II, which holds RMBS related to AIG’s secured lending portfolio, and Maiden Lane III) secret. As we demonstrate here, this information was not secret in the case of Maiden Lane III, but the repeated assertion that it was helped discourage further investigation.
The Fed claims that exposing the original and estimated current value of the Maiden Lane III CDOs would reduce the ability to realize maximum value from the entity. But that is spurious. In real estate, for instance, the ability to determine the owner’s purchase price and its appraised value is distinct from what a buyer might offer and a seller might accept. No one in New York City, for instance, believes that the owner of a condo (where buyer can find what the owner paid) has more negotiating leverage than the owner of an apartment in a co-op (where that information is not available). Any possible buyer of a CDO would do his own due diligence and valuation.
Knowing someone’s position size and cost basis can a give a buyer an advantage in liquid market (where dealers front run, or as they would more politely put it, get out of the way if they see inventory being sold and they think more is coming). But these are bespoke transactions in an illiquid market. The seller will have an idea of what its wares might fetch, and shops for bids. And even if a seller has a large position, if he can afford to wait and signals patience, he becomes much harder to exploit. And who can greater staying power than a central bank?
But more mundane factors make the “traders can take advantage of us” argument even more dubious. There is simply very little in the way of bids for CDOs. They are very difficult and costly to value if one does it correctly, and with so many moving parts, it is easy to be very wrong. And wrong often means you recover nothing. So the implicit idea, that the Fed’s exit is a sale of the CDOs as CDOs, as opposed to via liquidation, is also questionable.
So the reason for secrecy may simply be imperial reflex. But it might be to disguise the fact that the Fed is at risk of taking a loss on the Maiden Lane III loans, by showing that its current marks are unrealistic. While a mere $24 billion loan might seem unimportant in the context of a $2 trillion balance sheet, if Maiden Lane III’s valuation look generous, that calls into doubt the loans made to Maiden Lane I (the entity for Bear Stearns toxic waste) and Maiden Lane II (which holds some problematic AIG mortgage exposures). And the Fed is hoovering up such large amounts of paper on its own balance sheet, some of it outside its traditional, very stringent standards for lending, that small percentage losses there can add up to big dollar amounts. As Willem Buiter, former central banker, now chief economist of Citigroup, has pointed out, if the Fed takes enough losses on its forays into risky transactions, it will need to be recapitalized by the Treasury, meaning in the end by taxpayers. While the Fed in theory can “print” its way out of any credit losses, in practice that is constrained by the Fed’s inflation mandate:
….even if the central bank prices the private securities it purchases appropriately (that is, there is no ex ante implicit quasi-fiscal subsidy involved), it is possible that, should the private securities default, the central bank will suffer a capital loss so large that the central bank is incapable of maintaining its solvency on its own without creating central bank money in such quantities that its price stability mandate is at risk. Without a firm guarantee up front that the Federal government will fully re-capitalise the Fed for losses suffered as a result of the Fed’s exposure to private credit risk, the Fed will have to go cap-in-hand to the US Treasury to beg for resources.
Buiter argued that a recapitalization would cost the Fed its independence. Its high-handedness on secrecy looks likely, and deservedly, to produce the same outcome.
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Much less fun to do I’m sure, but Article 1 Section 7 and 8 of the Constitution specifies the powers of Congress in each of its two parts. To the house is allotted the power to raise taxes and stuff (on a uniform basis),issue debt, and issue currency (coin). The House also has the power to act against counter-feiters. Done without Congressional approval,oversight, or investigation, under a blanket of secrecy, there is what might be a straigh forward, prima facie case to be made that Bernanke has been counter-feiting US obligations and monetary instruments. Maiden Lane II, and the rest of the same old, might be best examined in that light, to seize the initative back from the money-power, its edgie hedgies and apologists.
I think Buiter’s concerns about inflationary danger surrounding the need for the Fed to “print” it’s way out of the Maiden Lane mess are somewhat misplaced. If those assets were fairly valued wouldn’t it be *deflationary* if they did nothing? It would be nice if someone could flesh out Buiter’s worries.
What remains unclear is how much of these Maiden Lane CDOs are synthetic. As to those which are synthetic, what makes them ‘assets’? Am I correct in assuming there is no payment stream on synthetic CDOs? That these things were created only for insurance purposes? In what way did the Fed acquire an asset by paying off AIG’s losing bets?
As I indicated yesterday when you raised this issue, most of the transactions are hybrids, which means a mix of cash and synthetic exposures (bonds and CDS, in layperson-speak).
If you answered this yesterday I am unable to find your answer. It seems to me that AIG’s exposure to a synthetic CDO cannot possibly be an asset. Is it not true that when the Fed paid off the counterparties the premium stream disappeared? What then is the source of value in Maiden Lane III?
You guys are great.
A 2 page document that highlights the missing pieces of the puzzle is genius.
Send it off to the FCIC and get them to fill in the blanks.
It’s a lot more difficult today for the FED to argue for secrecy when they are asked specific, detailed questions on the gaps you’ve so clearly identified. Let them explain why the missing bits are more sensitive than the publicly available information.
Well done!
This is a very nice beginning.
I am beginning to sense that the Fed may have gone beyond its legal authority. This also points with fair clarity that AIG and its counterparties may have been engaging in a mutual fraud.
How ever they are constructed, CDOs do not have an expected value that comes close to face. The CDO is merely an index upon which one might speculate. Therein lies the crime. Each of the parties is entering into a contract wherein they each speculate as to an outcome. The fraud occurs when the stipulated outcome occurs and the liable party cannot perform.
As to the Treasury, given this information it is clear that the only reason to want to withhold information from public scutiny is the potential for criminal liability.
Knowing central bankers, I dare say that one reason for secrecy is simply hubris. Central bankers tend to be people who are defined mainly by their academic achievement, so they are pathetically averse to being shown to lack knowledge or understanding. In my opinion, transparency is actually more important in a central bank than a private sector financial institution, because many of its functions are national monopolies meaning that it is immune to competition if it is doing a poor job.
Knowing humanity and the human beast, I will say that this is a criminal enterprise run amok and run poorly. I hope that you two will send your fine work in a legal memorandum to the AG of New York and let us see if he will use his considerable power to crack this open. A Federal prosecutor would have great effect if she or he attacked it as a RICO problem. Merci beaucoup to both of you. Keep swinging the big stick and remember : L’audace, L’audace, toujours L’audace. Cheers.
It looks like you guys are using the ABX.HE.BBB-.06-1 Index to value these tranches, but I could be wrong or not following your analysis correctly.
You should generally be using ABX.HE.AAA.06-1 or ABX.HE.AA.06-1, since those are the tranches owned by the Fed. You can tell because they are called “A1” or “A-1” tranches which are the “super-senior” tranches or put another way “the first to be paid back”. The AA and AAA refers to the rating at time of issuance, not what they are rated now. Even using these indices creates problems because the deals you are trying to value are predominantly from 2003-2005 which would be higher quality.
This isn’t to say they are worth par. ABX.HE.AAA.06-1 is at 80 cents on the dollar today, but at one time it was at 60 cents or less. I know the Fed has paper orginally rated AA, and that would have traded at under 25 cents at one time.
The CP tranches are a little different story and I would have to do some more research on them to come to a value conclusion. My understanding is that they were extensively over-collateralized.
Another factor you may consider is that in 2003-2005 filling CDOs with other CDO paper was pretty rare and would have been very limited. That practice really ramped up in 2006 because the mezz pieces were always the hardest to sell for the simple fact that the economics were very poor — so if you could just stick that piece in another CDO it made it a lot easier to get a deal done. This practice though was absolutely terrible and was one of the downfalls of the CDO market. CDOs of CDOs did nothing more than drive up leverage in already levered vehicles — very destructive.
As a side note:
Some people have always referred to these tranches by their original rating, I have always proposed referring to them by their attachment points (for example you would call the “A-1” piece in a CDO the 75% piece because it funds 75% of the collateral) which would avoid this problem since the attachment points never change but the rating obviously can.
Let me make a correction because I started confusing the CDOs with the underlying MBS.
Put simply: you are using a BBB- index to value the underlying collateral (the MBS), while the reality is that most of the underlying MBS would have originally been of higher quality — AAA, AA and A-rated and so you would have to use a different index. Not to mention the CDOs are from vintages prior to 2006. The MBS are also over-collateralized because the Fed is holding the super-senior piece of the CDO. Finally, we don’t know exactly what is in those CDOs — what percentage are other CDOs, for example? Or were there any synthetics with Lehman as a counter party?
And this is another question: what carrying value did the fed accept these instruments at? Par? or something less? That may be in material and I’ll look.
In short, these tranches are very difficult to value without having the right tools. But, with the right tools, they are not hard. There is a program called Intex that the banks use that can assemble these portfolios and run cash flow projections based on all the underlying collateral. Without seeing the assumptions and collateral it’s hard to second guess their valuation.
Your stab at valuing them raises interesting questions, but ultimately your methodology is too simplistic (though no fault of your own) to conclusively assert that the valuation the Fed is using is wrong.
Jeremy,
I suggest you read the post more closely and look at the post earlier this week that it links to.
Our objection to the Fed’s/BlackRock’s valuation is not based on our valuation efforts. There are vastly more obvious red flags.
As I described in a post earlier this week in some detail, the combination of greatly increased cash distributions coming from Maiden Lane III in 2Q and 3Q 2009 is inconsistent with the rising valuations reported for what remains. The portfolio is severely distressed, and the small portion that is not severely distressed saw meaningful downgrades during this period. Even though bond prices rallied over this timeframe, this was not true of severely distressed mortgage credits. This is confirmed not only by looking at the various ABX indexes, but also by conversations with market professionals. Basically, no one was buying this paper before the Fed QE-related market rally began, and the general rally did not extend to BB+ and lower rated ABS CDOs OF ANY VINTAGE. The combination reported is simply implausible on its face.
For purposes of this exercise, we looked at the available information, did some basic calculations and compared it to what had been disclosed to date (which was very little).
The mezzanine CDOs were valued with the BBB tranches of the relevant ABX index (depending on vintage). most of the bonds in these deals were rated BBB or BBB- at close. So just using the BBB tranche is theoretically being a bit more generous (though it hardly matters by 2009).
The high grade CDOs were valued against the AA and A tranches of the relevant index. The older vintages were skewed a bit more to AA, the more recent ones had a heavier concentration of A. A few deals consisted of only AAA bonds. For them, only the AAA tranches of the ABX was used for valuation.
The implied recoveries of the relevant bonds were then allocated first to the senior most bonds in the CDO, which were the ones insured by AIG.
While many of the high grade deals invested in the mezzanine (AA and A) bonds of other CDOs, and these bonds would now have very little value,
I did not include this in the calculations because I don’t know the percentages that these bonds represent in the deal. This is fairly generous, especially for the 2006 high grade deals and, as a result, the value of these deals may be a good deal lower than what we have calculated.
Obviously, intex modeling would make the process easier, but that has not been offered by the Fed or BlackRock. Perhaps, further efforts to break down the wall of secrecy will lead to more transparent valuations. Until then, I think this is a pretty decent first step.
It seems from looking again at your analysis that the day the deal was done the Fed was underwater. Therefore this isn’t even a question of what transpired over the last year. This debate isn’t too dissimilar from saying you don’t believe any given statistic from the government or the Fed. To that point I have no argument.
I’m not sure I follow you – how is this analysis simply a rejection of government statistics? I see it as a way to try to understand the Fed’s numbers, the AIG portfolio and the Maiden Lane transaction, in the absence of any transparency.
Our approach is not a back of the envelope calculation, or an attempt to back into any position. We did not, as you suggest, simply rely on the BBB- tranche of the ABX index. We used deal by deal analysis and valued the deals based on their key credit characteristics against a visible, transparent benchmark. The Fed may have done this when the Maiden Lane deal was created, but we don’t know. Consequently, we don’t know what this 47% valuation means.
In November 2007, AIG’s CDO portfolio was valued by various third parties. Though several of the banks were overly generous in their marks (over 90% mark on a mezzanine CDO, for example), our deal level estimation of value ties out fairly closely (suggesting we were not being overly conservative in our valuation), on an aggregate basis, with the level provided by the banks.
When we applied this same approach to the portfolio at the time of the AIG bailout, we find the CDOs have declined in value, not surprisingly, given the weakening credit performance of the underlying collateral. This time, the Fed provides the third party valuation of the portfolio, rather than the banks. The Fed’s value for the portfolio appears to be higher than ours.
Likewise, when we apply the same approach today, our analysis suggests the CDOs have continued to decline in value, driven by weaker housing and employment conditions. The Fed information appears to show that the Maiden Lane portfolio has not declined significantly in value. While spreads have rallied in recent months, the CDOs, including the senior classes insured by AIG, continued to decline in credit quality.
Without detail from the Fed on the portfolio, we have no way of understanding what the Maiden Lane numbers mean or how they are getting to them. Our approach provides a straight forward way of measuring the value of the CDOs in AIG’s portfolio and it raises questions about the Maiden Lane numbers and, of course, the level of Fed transparency.
By now I have read almost everything completely. I’ll admit my first post was more off general knowledge of the market in question and ML III than an in-depth research project, but the nice thing about blogs is you can learn as you go.
I’m not here to defend the Fed I just think the valuation is fun. I’m not going to get into political arguments, name calling, the proper role of the Fed or what have you over this issue.
Anyway, let me first lay out the valuation issue as I see it:
1) Par value of portfolio was $62.1 billion (from your post, but looks accurate based on limited par value information in ML III financials).
2) Fed provided $24.6 billion financing to purchase portfolio for $29.6 billion. As a part of a balance sheet true up when the deal was closed, the Fed immediately received $300 million of paydown on the loan.
3) AIG contributed $5 billion as equity in ML III.
The above implies ML III took over the portfolio at 47% of par — already a significant discount.
From the period the deal closed to 9/30/09, it appears the portfolio has generated $5 billion of cash — this would no doubt have occurred through principal repayments not repayments of interest. It seems to be part of your contention that this figure is high, at least in relation to the current portfolio value, but let’s address the $5 billion in a vacuum first.
When a CDO becomes distressed, all cash flows from the underlying portfolio, in this case the MBS, get swept to the senior tranche of debt which can create very large paydowns. Given especially that the underlying securities are MBS which can amortize very quickly in a falling rate environment, the $5 billion figure seems very reasonable. The fact these are older vintages does play a major role because it means home owners can refinance the mortgages in the MBS which is the primary means by which an MBS amortizes.
Now let’s look at the portfolio valuation as of 9/30/09 of $23.5 billion. If you add the roughly $5 billion of cash the portfolio has generated, it would imply a valuation of $28.5 billion, which is a slight drop from the initial valuation of $29.6 billion. Given the stabilization and indeed improvement of many CDO tranche prices in the market, this seems reasonable. Key to this point is what these tranches are — they are not the mezzanine tranches of the CDO, the are the senior and super senior tranches of early vintage CDOs. Indeed there are even some CP tranches in the portfolio which are typically highly over-collateralized.
All this points out another issue as well, that AIGs equity in ML III has been impaired by about $1.5 billion.
Unfortunately, we are now left (mostly) with a simple valuation debate. I don’t think the analysis based on the BBB- ABX index is appropriate which is what your valuation rests on. I do think that 45% of par for a portfolio of senior and super-senior tranches of ABS CDOs is roughly appropriate and I see no problem with this portfolio generating $5 billion of principal paydowns in this environment.
Let’s step back a minute though. I completely agree that the Fed should be more open about the portfolio. In fact, why not make the valuations public? I have no problem with that. But regarding the valuation of the portfolio based on public information, I think there is plenty of room for reasonable people to disagree and it is not at all certain that the Fed is underwater.
PS And you are right no there were no buyers of ABS before Fed QE — but afterwords and certainly over time super-senior tranches which is what the Fed “owns” (sort-of) were quite well bid and I could not find any that looked outstandingly cheap to my view of fair value in 3Q09.
By the way thanks for the debate :).
Jeremy,
Earlier in this thread, I stated the objection we made in the post to the ML III valuation was set forth in greater detail in an earlier post, and gave a summary of the argument. Yet you continue to misconstrue what I said, even in this thread, and apparently did not bother to look at the older post.
I suggest you familiarize yourself with our argument, rather than attack your straw man.
First, one of your statements is incorrect. When paydowns of MBS start, they do not “get swept to the super senior tranche” of a CDO. They go to the senior tranche of the RMBS, and only later, if there is sufficiently large paydowns, do the AA and A tranches of the RMBS receive principal payments, which then would lead to distributions to a CDO. Yes, there is sometime junior AAA RMBS exposure in a CDO, but we are speaking in general terms.
And even to the extent that there are principal paydowns, it is not a given that principal payments will go to the super senior tranche. In addition to CDO buckets, most high grade ABS CDOs had large (up to 30%) fixed rate buckets (and this portfolio is substantially high grade ABS CDOs).. These fixed rate bonds were mainly prime mortgages but had large prepayment risk. These were hedged with plain vanillia interest rate swaps (often struck a bit off market to inject upfront cash into the deal), so effectively the CDO was selling interest rate vol. In order to do a proper NAV analysis of a CDO tranche you need to figure out the current mark to market level of the interest rate swap (deal pays fixed, counterparty pays floating). The MTM in the current environment is significantly negative.
So if the cash flows become impaired, the default on the swap leads to swap termination. The swap becomes the senior liability of the CDO, senior to the “super senior” payments.
Second, we never disputed the idea of MBS paydowns as you suggest; indeed, the earlier post which you did not deign to read gave it as the only plausible reason for the sudden uptick in cash generationin 2Q and 3Q 2009 from the CDOs.
Third, the issue we raised was very basic. The effect of paydowns is:
1. Reduced remaining principal in the CDO
2. Almost certain lower quality of what remains. Refis likely account for the bulk of the cash distribution, given current loss severities on foreclosures (70-75%). And if there were a lot of foreclosures, that makes the principal reduction of the CDO even more severe relative to cash generation than in a refi (ie, this dynamic would be more pronounced).
So absent any market price changes, you would expect the value of the remaining assets in ML III to fall (the cash portion is reported separately in the quarterly reports).
Yet the Fed/Blackrock reported an increase in the price of the non-cash portion of ML III. This is implausible given that appetite for severely distressed CDOs did not increase during this period (confirmed not just by ABC prices but also by the recollection of market professionals. The rally in the credit market generally did not extend to the type of paper in ML III).
Believe me, if you bid 45% for this portfolio, I guarantee BlackRock would be all over you like a cheap suit.
I did read the earlier post. If I missed something, it was an error on my part, not a deliberate attempt to obfuscate.
There is no reason to start accusing me of setting up straw men. The way to handle accusations of using logical fallacies is simply to walk through how the argument is wrong, not to point out fallacy itself. What is the straw man I set up?
I do understand your point highlighted after you wrote “Third, the issue we raised was very basic.” I wrote about the issue very specifically that with the improvement in the market a loss of $1.5 billion on the portfolio over the first three quarters was in the realm of reasonable.
However, I don’t think you even need to go as far as you are going to make your argument, as I later wrote. From the work you have done, you can claim that on day 1 of the transaction, the valuation of some $30 billion was wrong. I believe the number in your work gave a valuation of $20 billion. Let’s therefore drop the intervening period as a discussion point and simply focus on the initial valuation.
Specifically, I cannot in any way refute that when the deal was done the portfolio was in reality worth 30% or par or 47% of par. To get that level of specificity you would absolutely need to tear the entire portfolio down to it’s constituent parts and do a real valuation — and still, it’s perhaps possible that two reasonable people could disagree on the value within that range.
Let me continue so you know I did read your entire post, and am not avoiding anything. You make excellent points about how the cash flow on the MBS and the CDO would likely work over the first three quarters of this year! All those points are arguments in favor lower cash distributions.
Regarding a bid at 47% right now, yes I am quite sure they would be happy with that since that would wind up the portfolio. There is no question these positions are illiquid — just by virtue of their rating none of the original buyers could purchase them at any price. If these positions were marked to market based on what they could, as a whole, fetch today in the market, I agree that 47% would be too high.
If I am missing adressing anything or not adressing it fully, it’s simply a mistake, just point it out to me.
Jeremy,
I must say I find your comments puzzling. You say you have read the posts (well you say “almost all”) and that your intent is not to set up straw men, then the balance of you comment does precisely that.
You appear not to have read the post which discusses why the ML III valuations look questionable. You then set up a first straw man, which is that to assert that we say that the ML III portfolio increases ALONE are suspect. It is not the increase in the portfolio value, it is the increase in the portfolio value IN COMBINATION WITH the significant uptick in cash distributions, which I enumerated and also provided links to the pertinent quarterly statements. I made that remark earlier in the thread (in terms of when I posted it, it appears shortly below due to the back and forth we have had). It was also in the post earlier in the week I suggested you read. Yet despite my both stating and pointing you to the argument, you misrepresent it.
And the earlier post also provides ABX prices and mentions that we have feedback from traders that confirms that there was no increase in appetite for this sort of paper over the relevant time frame (and that assumes they are using some notion of market pricing for valuation, which is dubious. It is far more likely that BlackRock is using model-based pricing, but given that defaults are not undershooting forecasts and loss severities are only getting worse, it is also hard to point to any fundamental factors which would justify a 15% increase in a model based price either).
You raise a second straw man, in commenting on a $20 billion figure shown in sample model output versus the $29.6 billion value assigned to the assets at the time of the Fed bailout.
The reason for presenting the models is to debunk the basis of the Fed’s secrecy claims and show that substantial transaction-level detail is in the public domain. Did we ANYWHERE in any of the posts refer to the model’s results as a basis for questioning the Fed’s/BlackRock’s valuations? No. The post that thumped on valuation was published days before the one about the model. In the posts on Friday that presented the model did say that a desire to hide dubious valuations was a possible reason for the Fed being so insistent on secrecy, and that the Nov 2007 marks for mezz CDOs looked rich. That was a whole year before the bailouts.
We did some valuation work in the model to see how far down that path we could get from public data, and to see if other readers might have other public information we had missed (or offer to assist with Intex runs). Nearly half the second post discussed anomalies and gaps. That clearly said the valuation effort was far from complete. Yet you pick a number out of a model we presented simply to show the structure of our analysis as if it were had used it to back up a substantive point, when we did no such thing.
“You then set up a first straw man, which is that to assert that we say that the ML III portfolio increases ALONE are suspect. It is not the increase in the portfolio value, it is the increase in the portfolio value IN COMBINATION WITH the significant uptick in cash distributions…”
This isn’t true statement of my case and I will take the blame for not making my position clear. I meant to state that I believe based on my analysis of the facts that it is possible the portfolio + the value of the distributions had lost $1.5 billion over the 9 months. $29.5 bil original value – $5 bil distribution – 1.5 bil MTM losses = $23.5 bil today’s portfolio value. I take that case as highly plausible.
On the second point, I will give you full credit and thank you for stating this plainly. The Fed’s claims to secrecy are circumspect as you suggest, but your valuation differential versus the Fed alone does not qualify as a “basis for questioning the Fed’s/BlackRock’s valuations”.
I’m afraid you guys would have to spend a few bucks to get the information to start valuing these. I would start with Moody’s Wall Street Analytics, which can get you portfolio positions as of the last trustee report as well as portfolio metrics. They track nearly all these deals closely from what I was able to find out.
I think you guys should consider releasing your work to your readers and make this an open source project. You are in effect calling for the Fed to open up it’s valuations (I think, correct me if I am wrong), so it’s only fair you open your own. I don’t have the time to reconstruct the portfolio, but I can spot check your marks.
Jeremy,
Earlier in this thread, I stated the objection we made in the post to the ML III valuation was set forth in greater detail in an earlier post, and gave a summary of the argument. Yet you continue to misconstrue what I said, even in this thread, and apparently did not bother to look at the older post.
I suggest you familiarize yourself with our argument, rather than attack your straw man.
First, one of your statements is incorrect. When paydowns of MBS start, they do not “get swept to the super senior tranche” of a CDO. There is a fair bit of variability, but in most cases, they go to the senior tranches of the RMBS, and only later, if there is sufficiently large paydowns, do the AA and A tranches of the RMBS receive principal payments, which then would lead to distributions to high grade CDO. Yes, there is sometime junior AAA RMBS exposure in a CDO, but we are speaking in general terms.
And even to the extent that there are principal paydowns, it is not a given that principal payments will go to the super senior tranche. In addition to CDO buckets, most high grade ABS CDOs had large (up to 30%) fixed rate buckets (and this portfolio is substantially high grade ABS CDOs). These fixed rate bonds were mainly prime mortgages but had large prepayment risk. These were hedged with plain vanillia interest rate swaps (often struck a bit off market to inject upfront cash into the deal), so effectively the CDO was selling interest rate vol. In order to do a proper NAV analysis of a CDO tranche you need to figure out the current mark to market level of the interest rate swap (deal pays fixed, counterparty pays floating). The MTM in the current environment is significantly negative.
So if the cash flows on the fixed rate bucket become impaired, the default on the swap leads to swap termination. The swap becomes the senior liability of the CDO, senior to the “super senior” payments.
Second, we never disputed the idea of MBS paydowns as you suggest; indeed, the earlier post gave it as the only plausible reason for the sudden uptick in cash generation in 2Q and 3Q 2009 from the CDOs.
Third, the issue we raised was very basic. The effect of paydowns is:
1. Reduced remaining principal in the CDO
2. Almost certain lower quality of what remains. Refis likely account for the bulk of the cash distribution, given current loss severities on foreclosures (70-75%). And if there were a lot of foreclosures, that makes the principal reduction of the CDO even more severe relative to cash generation than in a refi (ie, this dynamic would be more pronounced).
So absent any market price changes, you would expect the value of the remaining assets in ML III to fall (the cash portion is reported separately in the quarterly reports).
Yet the Fed/BlackRock reported an increase in the price of the non-cash portion of ML III. This is implausible given that appetite for severely distressed CDOs did not increase during this period (confirmed not just by ABC prices but also by the recollection of market professionals. The rally in the credit market generally did not extend to the type of paper in ML III).
Trust me, if you bid 45% for this portfolio, I guarantee BlackRock would be all over you like a cheap suit.
Yves and Tom, thank you for responding so well to Jeremy. He illustrates the presentation-to-a-jury problem quite well. I can only hope that you formalize your presentation and submit it to the NY state AG. It would make compelling news and serve as a lever for him to act. You guys carry weight in the blogosphere and your work could be the catalyst to get more than SEC mediocrity and Obama hyperbole.
If I had the portfolio I know enough about valuing these types of assets to do the valuation myself. It would take a lot time, since you would need to go through the deal docs on all the CDOs and the underlying MBS and figure out how the cash flows work. I do not therefore represent any sort of presentation to a jury problem. If you want to associate me with a problem, it’s that even experts can disagree about a 15% valuation differential on a portfolio of this type.
This really in my mind brings up the core issue here. We are talking about a valuation differential of only 15-20% as a percentage of par. People can disagree about a 20% differential in value for most risky assets. Even greater differentials can be ascribed to difference of opinion. Is the stock market properly valued at 15x earnings or 10x? What about 35x? How about a private company at 4x ebitda or 7x ebitda? These types of cases go to court all the time for tax issues or due to partnerships breaking up.
In my view, you’re going to have an extremely tough time saying $30 billion was overvalued versus $20 billion for these assets.
Keep working ,great job!
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Ok now I am sacred, the implications that the fed might one day be bankrupt from the risks they take but cant value might implode. So once again the treasury to the rescue. But wait being scared all the time from all of the confusion of the finiancial meltdown is bound to make one knumb and just go thru the motions to plug away in life. Why are us regular Americans knumb?? The fed gubmint takeover on some of the basics of our free society, Fannie Freddie mac, GM etc… all to the backs of the whomever are ‘the taxpayers’, but life is going on I still have my internet and cold beer. I have yet to see one person explain what happened, Yves and Naked Capatialism are doing a very admirable job of digging into the truth and are to be commended as American Patriots. The sad commentary on our society these days is how we have churned out so many educated smart people whos only ambition was to make money thru business degrees, politics et al. The enginners, scientists have been phoophooed, They are the ones who have created true wealth. Equations and especially linear equations need to be left to real engineering problems and not economists and global warmist alarmists. As the lay pple are now discovering linear equations always eventually cause a divergence over time that accelerates exponientally. Do I see an ominious sign of litigation over this finiancialy mess now and it growing exponientially and more confusion on us poor lay people who just want to plug away in life and maybe have a just a small bit of wealth??
I hope this didn’t get lost in the wall of text — but I do agree that ML III should be opened up. I do not agree with secrecy at the Fed. I think the Fed should be very transparent. I think the Government’s spending should be more transparent than it is as well.
That said, I don’t think this debate is going to be won by playing gotcha with a valuation differential on the ML III portfolio. It can’t hurt though, so I applaud your efforts!
If I were still working in that part of the industry I would query some of the desks on what super senior 2005 vintage CDO tranches were trading at… Perhaps some other reader can give some input?
Actually maybe I can help here, let me look into it.
Have you guys posted the portfolio with the marks you have calculated on a position by position basis?
Alternatively, if you could at least answer a question regarding this document: http://www.scribd.com/doc/25577625/Maiden-Lane-III
On page 2, if you reference the top of the page where you list “par” and “mark” next to each other, does that reference what you have calculated today’s mark is on those securities? So for example, next to Wachovia, do you assume those positions are worth $752.8 million?
Thanks.
If you guys can answer this question, it would be helpful.
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Very interesting post
Did you guys publish the details and results of your “second model” as well? I’d like to take a look to that
Thanks