Sage Words

Remember Andy Beal?

Now firmly back in his industry of expertise, he penned this letter in today’s Wall Street Journal.  Read it and think.

To: Mr. Ben Bernanke


“Dear Mr. Bernanke:

I was afraid that if simply wrote you this letter you might never see it. I thought this message was important and worthy of effort to attract your attention.

I am sure that you are hearing from the Wall Street crowd about how stupid the marketplace is because the market won’t buy all the great loans that Wall Street has produced and how stupid or illiquid the market is because AAA RMBS are being offered at 60 cents on the dollar with no takers. First mortgage synidcated bank loans are offered for 70 cents on the dollar and Wall Street simply cannot believe buyers aren’t standing in line to buy.

Consider for a moment that many corporate bonds are trading at premiums above par value. How can this be? If the market is so stupid and there is no liquidity, who is buying those good corporate bonds at 105 cents on the dollar??

Many AAA mortgage bonds are actually extremely high risk because of little-considered nuances in the hundreds of pages of trust indentures and servicing agreements. In addition to widely understood mortgage default and other concerns, these contracts permit the loan servicers to advance payments on behalf of defaulted homeowners for years and years and years at interest rates of 12% and more. These “servicer advancements” put funds back into the trust to be paid out to junior security holders. The “servicer advances” are subsequently repaid FIRST from foreclosed home sales. Therefore, foreclosed home sales may result in little or no proceeds, or even a liability, to the AAAs. This mechanism effectively transfers funds that really should belong to the AAA securities to junior securities. Servicers that own junior securities are incredibly motivated to drag their feet resolving defaulted loans, which results in great loss to the AAA holders. This is not a misprint: Defaulted first mortgage home loans may become a net liability, not an asset, to some of the AAAs. This is still not widely understood.

Simlarly, “first mortgage syndicated bank loans” issued since about 2004 are routinely garbage and not traditional first mortgages on anything determinable at all. Many, if not most, of these loans permit the borrowers to sell the collateral, keep the money, and reinvest in almost anything they want to, including stock, junk bonds, defaulted loans, or perhaps ice cream cones. MAny, if not most, of these syndicated bank loans also permit UNLIMITED amounts of additional swap debt that is either senior to or of equal priority with the syndicated loan. These provisions are also no widely understood and are sometimes even disguised in the loan documents.

Falling prices for these type assets reflect people finally reading the hundreds of pages of fine print, not a problem with the marketplace. Prices should continue to fall as people wake up to the true nature of these assets. Mant “last out” AAA RMBS are still overvalued at 60% of par. Many first mortgage syndicated bank loans are overvalued at 70% of par. Smart buyers won’t touch any of this garbage at any price remotely close to what it originally sold for.

The Fed may be walking on very slippery ground. My fear is that the Fed has little more undersanding of the stench of the garbage than many of the current owners who bought all these debt instruments issued about 2004.

Is the US Governmenttaking some of this garbage on its balance sheet as collateral for Federal Reserve loans? The AAA rating means absolutely nothing. Garbage is garbage even in a fancy wrapper that the ratings agencies love.

I do not pretend to know how the Fed is collateralizing loans. Perhaps I am naive in underestimating the insightfulness of the Feb, but many intelligent people were caught up in complacent decisions involving these assets. I know nothing more than what I read in the media about collateral for these Fed loans, but it sure sounds troubling.


Andy Beal
6000 Legacy Drive
Dallas, Texas 75024

3 thoughts on “Sage Words

  1. Ben Bernanke could care less, it’s not his money!
    If they monetize this debt then we all should consider our mortgages paid through our taxes.

  2. The Fed is not quite “collateralizing” them.

    They are simply accepting them at some price point as collateral for cheap loans to financial institutions to keep liquidity in the system.

    I wish I could remember the source article where I read that bit, but I think I heard a good explanation of it on NPR market.

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