A Baby Step

Transparency in the mortgage bond market just got a baby step in the right direction.

Yesterday the SEC approved FINRA’s plan to tell the world where some Agency MBS and small business loan (SBA only) bonds are trading.  FINRA is the brokerage industry’s self-regulator, so the fact that it’s only a baby step is no surprise.

I’m reminded of the scene five years ago, when short sellers and CDS “insurance” buyers used complicit or ignorant reporters and the opacity of the structured securities markets to turbo charge their profits.

In fact, they made the mortgage meltdown worse through their actions.

During the heart of the meltdown, there were hedge fund managers telling the world that they intended to sue accounting firms unless those firms used the ABX index of CDS to value mortgages and bonds in bank and mortgage lender portfolios.  But the ABX was as much as ten to twenty points lower than the component bonds were trading in the cash market, so the implied losses for the owners of those mortgages and bonds were vastly overstated.

The hedgies were selling the stocks of all the mortgage lenders short, so those lenders weren’t able to raise equity capital.  The hedgies also bought huge amounts of credit insurance on those companies, effectively drying up their access to credit markets, including bank loans and lines of credit.

Since the subprime market in particular was almost exclusively  non-bank financial companies, there was no alternative to bankruptcy for those lenders once the private credit and equity markets dried up.

Their failure eliminated half the mortgage lending in the country.  What happens to any market when half the buyers are frozen out?

Now you know why the value of your house dropped below your mortgage, even if you were a responsible borrower that put down 20% cash and didn’t lie on your application.  And that’s why Fannie and Freddie failed, when millions of responsible borrowers in “prime” mortgages had life situations that forced them to sell their homes.

The reason this all worked so well for the “heroes” of Michael Lewis’ The Big Short is that their actions in the CDS derivatives market was completely hidden, their disinformation campaign about the value of mortgages in the pipeline and bonds in the portfolios was happily adopted by the press, and, in the end, both irresponsible and responsible borrowers bore the pain, along with taxpayers.

But now, at least, actual bond trades in a tiny corner of the market (specified pools of Agency MBS and SBA loan securitizations) will be visible.

It’s really too bad that the declines of 2007 and 2008 were so grossly overstated, and hidden by the over-the-counter market.  It was gasoline thrown on the fire. We’ll all pay for that for years.



One Response to A Baby Step

  1. Conscience of a Conservative says:

    I’m intrigued by FINRA’S decision in favor of transparency by releasing TRACE pricing but obscuring the identity of the bonds being priced by removing CUSIPS and making the bond descriptions generic. How useful will this be? Two AA Alt-A seniors can be very different securities. Gotta love transparent obfuscation where would we be without it.

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