There’s an interesting article in the Financial Times suggesting that the actual value of the “troubled assets” being held by banks may be substantially lower than the banks have been claiming they are:
But now, at long last, one shard of reality has just emerged to piece this gloom. In recent weeks, bankers at places such as JPMorgan Chase and Wachovia have been quietly sifting data trying to ascertain what has happened to those swathes of troubled CDO of ABS.
The conclusions are stunning. From late 2005 to the middle of 2007, around $450bn of CDO of ABS were issued, of which about one third were created from risky mortgage-backed bonds (known as mezzanine CDO of ABS) and much of the rest from safer tranches (high grade CDO of ABS.)
Out of that pile, around $305bn of the CDOs are now in a formal state of default, with the CDOs underwritten by Merrill Lynch accounting for the biggest pile of defaulted assets, followed by UBS and Citi.
The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.
and urges an open sale of these assets:
But in a world where investors already feel utterly terrified by the inability to determine values – and the recovery rate on triple A assets has tumbled to just 5 per cent – conducting an open fire sale might now be the least bad of some terrible options.
After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear; and if it is higher than zero, it might even cheer investors up.
Clearly, that’s just the outcome that bankers are hoping to avoid. And for good reason:
Hitherto, most bankers – and policy makers – have vehemently resisted that idea since they feared that public sales would produce painfully low prices. That is a valid fear. After all, there are very few investors in the system right now with any appetite or capacity to take risk.
In the dark all cats are black and in the absence of actual, real-world price discovery apparently that’s true of financial statements, too.
