Tuesday, July 29, 2008

What worth a CDO is?

Collateralized Debt Obligations (CDOs), the securities backed by mortgages in America which are the root cause of the current financial crisis on Wall Street, posed an acute problem of valuation so far. ( http://en.wikipedia.org/wiki/Collateralized_debt_obligation ) JJ Cramer and many market analysts have been lamenting that unless there is a credible number attached to what is a worth of these CDOs we are unlikely to get out of this mess. That reasoning is correct. As Fed increased interest rates starting in mid-July of 2006 and American Economy failed to hold steady / increased income for inflation battered Americans; everybody started to realize that Americans will start defaulting on their mortgages. Very soon, indeed. So naturally CDOs which are backed by these mortgages started to loose their values. The problem has been to determine the extent of value loss – 10 cents per dollar or 20 or 30? Initially folks started to say reduction in CDO valuation will be proportional to the underlying mortgage default rates. Even though mortgage defaults started to spike; the traditional number of less than 5% defaults would go at the most less than 15% or 20%. But the financial wizardry of behind these CDOs is so ingenious that these CDOs loose value much more than the underlying mortgage default rate. This means market realized that CDO loss will be for surely more than 15% to 20%. But how much? And that was the literally multi-billion dollar question on the Wall Street till today.

With Merrill Lynch selling its CDO portfolio of $30.6 Billion CDOs for paltry $6.7 Billion; the whole world has got the answer to this valuation question, seemingly the basic key to move beyond the current mortgage crisis. The answer is these CDOs are worth 22% of their original face value! Incredible destruction of value peddled by these so called Masters of Universe. When will we gullible public realize that Wall Street is nothing but a giant casino created to enrich CEOs and CDO creators but to dupe pennies and houses from all other common Americans? Will we have a righteous sermon from the high priest of Capitalism - Wall Street Journal - admonishing mandarins of Wall Street and articulating a system which is not so value destructive? Probably not. That is not in the tradition of these ‘self-help style American’ custodian of Capitalism. It is symptomatic of so many Conservatives, pro Capitalist folk who on most occasion calls GOP as their home. Can one dare to say ‘Wall Street and American Capitalist System gone wild’ here? Barack, do you have any solutions here? Anyone stepping forward to articulate a clean and right solution of supervision / regulation to avoid such mess in future? The parade of culprits in this supply chain of ‘CDO crack drug’ includes:
- Realtors and property appraiser who in the first place brought the froth to residencial market along with the high flying home builders.
- Next we got banks offering millions of dollars to NINA (no income no assets) mortgages.
- Then comes the ever eager class of Wall Street Investment Banks – Bern Stern, Merrill Lynch, Citibank of the world who bundled these mortgages into CDOs.
- Finally rating agencies like S&P, Moody played their crucial part of this great endeavor: offering ratings of high credit worthiness to these CDOs even though the mono-line insurance cover offered by likes of Ambiac, PMI have way too inadequate for these financial papers.
It has been total collusion and abdication of responsibility by all these players. Of course, while this has been unfolding SEC, CTFC, Fed and Treasury Department and even Congress; were all busy in ‘serving’ Americans. Folks, we have got one heck of a regulatory system in our country.

Meanwhile, we will start seeing balance sheets of CDO holders destroyed with reduced valuation ranging from 15% to 30% of the original CDO face value. This means so far $400 Billion write downs which have come on Wall Street will not be enough. In short, more misery and more grinding of all retirement portfolios of common people.

As they say in finance, the only silver line here is finally we are likely to see some handle on how toxic these CDOs are and that is always the first step – to know exactly how deep we are in the hole. As a trader on ‘TheStreet.com’ Robert Marcin writes:

Cramer can rant all he wants, but it's futile. Uncle Ben can't stop the Great Unwind, neither can Hank. Nor can Comrade Obama if elected president. The delivering [sic] of the global economy is a powerful force that most underappreciate [sic], including the 30 x's levered bozos running brokerages. Stay liquid.

That seems to be only truth with which we commoners have to live with. Everything else is Mirage on Wall Street and misery in the reign of King George Bush continues unabated.

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