Fed Sells Subprime MBS

With a shout-out to Jill, and a big “thank you” to Zach and Jody, I’ve been asked to opine on the latest round of Fed liquidation of Maiden Lane II.  For those who wonder what the innocent-sounding Maiden Lane series might be, those are the taxpayer funded “financings” of the AIG mess and the Bear Stearns subsidized takeover.

I’ve been wondering, along with the rest of the market, what Goldman paid for the bonds.  Jody Shenn at Bloomberg is on the case, and so far he’s only been able to determine that most of the bonds are still at Goldman.  A day later, I’m happy to report that Jody is now up on Bloomberg with his article about it.  Sometimes letting a blog post “age” overnight before publishing has its benefits.

The good news, if you want to call it that, is that the Fed figures this sale will complete paying off Maiden Lane II.

There is that open question:  At what price?

A cynic would say that the taxpayers just got out with a minimal return and Goldman got to buy cheap bonds after the worst of the subprime storm was well and truly over.  We warehoused the inventory, and then they got to pick what they wanted at a bargain price.  Such a deal.  So call me a cynic.

I’ve been more interested in how the liquidation game has been played.  It seems that the major players take turns putting up “stalking horse bids” for chunks of the Fed’s portfolio, and then the Fed responds by holding an auction to which only those major players are invited.  Possibly to maintain some appearance of propriety, the winner of the auction is usually some other player than the one that kicked off the process by making a bid.

When we throw in the news that a pair of CSFB derivative mortgage bond traders were so colossally stupid as to mismark their positions and talk about it in company e-mails and on recorded phone lines on the trading desk, we see that the question of price is quite easily manipulated.

That’s my main gripe with all the “hero” stories out there about the hedge funds that made a fortune off the meltdown, and my gripe with their mouthpieces in the press.  During the height of the panic, some of those hedgies were short in size in the Credit Default Swap (CDS) market, especially in the visible published index called ABX.

Some of those reporters dutifully reported that investors were considering suing any auditor that used any prices other than the ABX to set portfolio values for banks or investment funds that held mortgage bonds.  That was probably one of the main drivers for the unprecedented speed and viciousness of the US housing market’s decline.  After all, a score of other economies around the world had objectively higher housing costs.  But they didn’t have the same kind of apocalypse the US did.  What those other markets didn’t have was the leveraged casino of the CDS and its ugly public face, the ABX index.

There are now academic studies that prove the prices were WAY too low for the ABX, but that happens in any market where there are only sellers, doesn’t it?  Especially if the “natural” buyers were forbidden from taking a position.

I wrote about the crazy nature of the discrepancy in my book, Mortgage Market Mayhem. The hedgies were getting many times the leverage being offered in the cash market, and they took advantage of it by placing bets that were up to 100 times the size of that cash market.  In essence, they set themselves up to multiply the losses in the mortgage market BBB bonds by orders of magnitude.  When those losses were realized, the taxpayer paid at far higher prices than the market would have dictated.  The AIG disaster was almost entirely synthetic bonds, and the full face amount payments the government made to those big banks were mostly passed through to the hedge funds that were the “heroes” of books like The Greatest Trade Ever.  When Michael Lewis added to the public love fest for the vultures, I couldn’t help writing that muggers aren’t heroes.

Just because it’s in the paper or on the internet doesn’t make it true.  In fact, you should probably be twice as suspect when your politics agree with your source, like all my politically conservative friends that swallowed the big lie that Fannie, Freddie and Barney Frank caused the meltdown.



5 Responses to Fed Sells Subprime MBS

  1. Frederick W.H Collins says:

    Howard, don’t leave the question hanging. Who caused the meltdown?
    Alt-A mortgagee’s who weren’t required to validate income?
    Greedy mortgage brokers?
    Banks who loosened lending requirements to meet legislative demands?
    Bond houses who leveraged without adequate capital?
    Legislation requiring more diverse lending by banks?
    Fanny and Freddy buying at excessive leverage with implicit government backing ?

    If your answer is all of the above plus more, it’s probably closer to the truth than all of the finger pointing to one in particular.

    IMO, I think the housing bubble started when “stated income” was permitted. It introduced an element where fraud could be committed and that permeated all throughout the lending chain fostered by the inate greed of individuals and that led to the inevitable, eventual collapse.

    • hhill51 says:

      Fred —

      Your list is a little short, and you failed to see the major tax incentive that drove the “liar” loans (which were really only offered to high-FICO borrowers, not subprime).
      Check out Roots of the Meltdown and The Blame Game to see that everything you thought of, plus more, were here on my blog for a couple of years already.
      Lest you accuse me of leaving the question hanging about a solution, that’s already posted, too. I called the post “Two Years Ago”

  2. mindandmoney says:


    Step back to pre-September 2008 when we both were in the industry, you managing money for an insurance company and me, designing and building an electronic trading platform for ABS on behalf of a powerful Wall Street consortium.

    My personal professional success was tied to the success of the trading platform and yours to the success of your portfolio.

    Here I quote a passage from your Blog;

    “ When we throw in the news that a pair of CSFB derivative mortgage bond traders were so colossally stupid as to mismark their positions……………………….we see that the question of price is quite easily manipulated.”

    While I will be the first to admit that I had a strong personal incentive to seek price transparency, I will always wonder why the investors in these securities, the Buy Side, i.e. those folks responsible for investing trillions of dollars of other people’s money did not themselves promote transparency. In fact they resisted it vigorously.

    Therein lays the strongest root cause of the crisis. Both you on the Buy Side and me on the Sell Side understand perfectly. It’s about margins, compensation and the unrestricted concentration of power and nobody, including the employees of the Buy Side firms, wanted the party to end.

    Stephen Jencks
    Dhaka, Bangladesh

    • hhill51 says:

      Hey, Stephen….

      I hope all is well on the other side of the earth.
      From my time on the buy side, my best guess is that they didn’t want their competitors to know the price they were paying (on a bond by bond basis), so they resisted real time reporting of trades for that reason.
      The price database is a more complex issue. Accounting rules for hedging got so ridiculous after Orange County and LTCM that portfolio hedges had to be taken directly into the balance sheet, or even into current income. Only hedges that were exactly identified with specific portfolio line items (and defensible) were allowed hedge accounting. As we saw with the misuse of the ABX prices during the crisis, people with an agenda were able to force institutions to mark their portfolios at artificially low prices, adding to the avalanche of selling and misery.
      I recall once when my department (while still on the sell side) got a mark for an inverse floater with a then-current coupon of around 8% that was below 40 cents on the dollar. That same pricing service gave a price of 45 cents on the dollar for a principal-only bond that was an exact parallel principal pay bond. In other words, it was mathematically impossible for the PO to pay more dollars to the investor than the discount inverse, but the price was more than ten percent lower according to the service. All it takes is a couple of bad experiences like that, and a portfolio manager will tend to mistrust any external source of prices, especially those based on unrelated, but “similar” bonds.

  3. Conscience of a Conservative says:

    The Fannie/Freddie debate is a smoke screen with the real fight about which group vision gets to reshape the country. Chris Whalen had a great quote about Obama wearing Herbert Hoover’s Concrete Booties.

    In either case, I’m more worried about how current policies are putting the nail in the capital market’s coffin. We have zero interest rates which throws a huge monkey wrench in CAPM decision making, a Fed who is making what shouldn’t be callable MBS..callable, a president who has supported rewriting contract law to make private investors in 1st lien mortgages and not banks in 2nd liens bear the brunt of mortgage write-downs, and a lack of will by the DOJ to investigate and go after fraud.

    The way I look at it, whether its the Republican vision or the Democratic vision the rule of law goes away with more corporatism. In mortgages the way money is made now is by four large banks capturing half the spread of new mortgages being delivered to pools guaranteed by the tax payer.

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