Monthly Archives: February 2008

When The Music Stops

CDO Market Is Almost Frozen, JPMorgan, Merrill Say

For some reason this headline made me think of a brutal game of musical chairs where the music stops and the players are left with the option of jumping on a bed of nails or being kicked teeth first into the curb on the Street.

The never-ending slew of headlines on the deteriorating credit quality of these instruments only makes it more starkly obvious that the credit ratings placed on billions of these things were absolutely worthless.

Moody’s virtually acknowledged as much today (see this article) by suggesting that it might adopt a set of “warning labels” for their ratings! The fact that their rating methodology is so suspect that they have to create the equivalent of a skull and crossbones would be laughable if it weren’t so scary in its implications. In other words, Moody’s is saying “you know those $billions of securities we said were ‘AAA’…well…we didn’t reallly mean it”.

If the CDO market already froze up before such an acknowledgement, where do we go from here? What is the next market to freeze?

Maybe the murmurs in the leveraged loan markets will become full-fledged wails when the buyers in that market start to question the promise for their exit alternatives in a drying liquidity environment. What about CDS markets that actually have to consider counter-party credit risk? Probably not as easy to trade this stuff willy-nilly once you realize your insurer may not exist tomorrow.

Life is beautiful, but it sure does have a bad hair day sometimes.

Hedge Funds And Open Source

The world is really moving in an exciting direction notwithstanding of all of the recent madness in the markets. We are in the midst of what some are calling a “loss of privacy” on the one hand, while on the other hand we might instead call it “an improvement in information and transparency”.

Case in point: Bill Ackman, a notoriously bearish hedge fund manager, has recently written an open letter to the insurance regulators regarding his multi-year negative view on the bond insurance companies that have been in the headlines of late.

The coolest part of his letter is not only the public display of his thoughts, but also his sharing of what he is calling an “open source model” which he has made available for download and collaboration.

Take a look at the letter, some of which is quoted below:

Bill Ackman’s letter to insurance regulators

Our primary goal is to initiate what we call “Open Source Research” where all market participants can have equal access to the primary source data and construct their own views of losses without reliance on the analytical judgment of rating agencies or the bond insurance industry.

By focusing the discussion on a fundamental, data-driven approach, we expect that the dissemination of the Open Source Model will enable market participants and regulators to accurately estimate probable losses by relying on rigorous fundamental analysis of specific credit exposures, a departure from relying on the opaque, faith-based pronouncements that the bond insurance industry has promulgated to the marketplace.

In order to facilitate a comprehensive and accurate estimate of probable losses in the bond insurers’ exposures, we believe that you, as their regulators, must require the bond insurance companies to provide full disclosure to the market of their entire portfolio of insured exposures. This should include not only confirmatory data on CDO and related RMBS exposures detailed in the Open Source Model, but also municipal and other structured finance exposures, especially those exposures that have been or are in remediation, are rated below-investment grade, require claim payments or otherwise have been or are carried on so-called “classified watch lists.”

Only with a complete understanding of all of the bond insurers’ gross exposures to potential losses can the market gain a complete understanding of the insurers’ capital adequacy.

If the bond insurers truly believed that greater disclosure would help confirm the veracity of their loss estimates, one would have expected them to provide full transparency to the marketplace.

Download the model here
– But be careful. This thing is huge (128mb) so it might destroy your system.

Thanks to WLH for sharing this.