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$4 Billion Golden Oppoerunity

More Subprime and CDO Banking Problems

Interest-Rates / Credit Crunch Oct 25, 2007 - 08:29 AM GMT

By: David_Urban

Interest-Rates Security pricing used to mean you checked your Bloomberg terminal or the Wall Street Journal for valuation prices. Now, pricing has become so complex that it has been broken down into 3 separate levels. The short version is that if you are pricing by Level 1, the security is being market to market and based on market prices. Level 2 is marking to matrix where prices are based on dealer-pricing based on surveys or market bids and offers. Level 3 pricing is based on marking to model which is based on models or managements best estimates.


The increased use and reliance of models for the use of pricing securities has made me more bearish on the banking and securities sectors. When large firms are stating that 7% of their total assets are deemed Level 3 assets I have to ask about the true size of their exposure. Are we talking about 7% at par, marked to model, or marked to true value?

A couple of weeks ago I attended a discussion with one of the great value investors, Jean-Marie Eveillard, where he stated that he does not hold any banks because he does not believe the CEO's know what is on their books. After thinking about that statement for a week and reading about the ‘new way to price securities' I happen to agree. What is the true extent of the securities exposure where there is no market and what does the reported number mean? Do the CEO's truly understand the real exposure?

Citigroup and other big banks are planning a $100 billion fund which would buy mortgage backed securities and SIV securities. Citigroup itself has nearly $100 billion in seven affiliated SIV's. The creation of such a fund leads me to return to the cockroach theory where when one is seen you can be sure that there are more behind the walls. Earlier this year it was subprime lending, then CDO's, and now SIV's. What will be next? So many questions, Jean-Marie Eveillard was correct.

The fund being setup by Citigroup and others will help avoid future forced asset sales but does nothing to make investors feel more confident in the commercial paper market and help assuage the collateral crunch in the market. If nobody feels pain then nobody learns a lesson. It just creates a situation where more bad decisions will be made on top of the ones already made and more vehicles will be created to bail everyone out when they never learned the lessons they needed to learn in the first place. Meanwhile, people on the sidelines and trading pits will be watching and marking down the value of the securities to reflect the risk that the system will collapse unless it continues to be bailed out.

I am not trying to rub people the wrong way but as an investor I have to take off the rose colored glasses. Prices do not look attractive to me given the associated risk. Even in the Middle East , where banks have been showing phenomenal growth rates I cannot feel comfortable given the problems that are seeping out.

Thailand is another market where the CDO exposure was supposed to be negligent but the banking reports I read are pushing the last quarters CDO reserves aside. That tells me there are more negative surprises to come.

By David Urban

http://blog.myspace.com/global112

Communications are intended solely for informational purposes. Statements made should not be construed as an endorsement, either expressed or implied. This blog and the author is not responsible for typographic errors or other inaccuracies in the content. We believe the information contained herein to be accurate and reliable. However, errors may occasionally occur. Therefore, all information and materials are provided "AS IS" without any warranty of any kind. Past results are not indicative of future results.

PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS. THERE IS RISK OF LOSS AS WELL AS THE OPPORTUNITY FOR GAIN WHEN INVESTING IN THE STOCK, BOND, AND DERIVATIVE MARKETS. WHEN CONSIDERING ANY TYPE OF INVESTMENT, INCLUDING HEDGE FUNDS, YOU SHOULD CONSIDER VARIOUS RISKS INCLUDING THE FACT THAT SOME PRODUCTS: OFTEN ENGAGE IN LEVERAGING AND OTHER SPECULATIVE INVESTMENT PRACTICES THAT MAY INCREASE THE RISK OF INVESTMENT LOSS, CAN BE ILLIQUID, ARE NOT REQUIRED TO PROVIDE PERIODIC PRICING OR VALUATION INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN ONLY TO THE INVESTMENT MANAGER.

Before making any type of investment, one should consult with an investment professional to consider whether the investment is appropriate for the individuals risk profile.

David Urban Archive

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