Monday, March 30, 2009

Samuelson: Assets Just Need Some Love-erage

Count Robert Samuelson among those who insist that "there are no bad assets; only misunderstood assets". Per Samuelson:
"Deleveraging" has caused prices to plunge to lows that may be as unrealistic as previous highs.

Grasping this, you can understand the idea behind Geithner's hedge fund. It is to inject more leverage into the economy -- not to previous giddy levels but enough to reverse the panic-driven price collapse.
But has the collapse in assets prices been the result of panic or fundamentals? One study has shown that some CDOs are actually worth even less than what many pessimists thought. To counter the notion that the fundamentals justify the current depressed prices, Samuelson cites
one mortgage bond whose market value has dropped by roughly 40 percent even though all promised payments have been made and, based on the performance of the underlying mortgage borrowers, seem likely to continue.
Unfortunately, this description omits two key details: are the borrowers underwater on their mortgages, and do the mortgages reset in the near future? If borrowers owe substantially more than their homes are worth, then they have a powerful incentive to post jingle mail, and walk away from their mortgages, even if they could afford to pay it. And as the real economy continues to deteriorate, with unemployment rising and wages lowering, increasing numbers of underwater borrowers will likely be under greater financial strain; paying off a mortgage that dwarfs the value of one's house will make less and less sense. Likewise, if these are option ARM mortgages, then they will likely reset within the next year. Borrowers who can make their payments today may not be able to make the higher, reset rates. If either of these scenarios is the case, then discounting this particular mortgage bond 40% seems fairly reasonable.

Samuelson does hedge a bit, admitting that these current lows "may be as unrealistic as previous highs." Perhaps he realizes that losses in mortgages, in commercial real estate, and in credit card debt are all real. There is nothing panic-driven about these losses. And unfortunately, the wizards of Wall Street multiplied these losses several times over with synthetic CDOs and CDS bets. No, our major banks are very insolvent. And no amount of financial engineering - no matter how clever - will change that.

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