Posted by Karl Denninger
Last week we spoke to Jim Burke of Ramius Capital Group about the situation in the world of CDOs, a market that his firm tracks very closely since they assist in the liquidation of defaulted deals. “There were approx $480 billion of ABS CDOs structured over the years, of which about $410 billion have already triggered an event of default.” Burke notes. “I believe a majority of the remaining $70 billion of ABS CDOs will trigger an EOD over the next 1-2 years.”
Of the $410 billion ABS CDOs that have triggered an EOD, approx $160 billion have been liquidated or are in the process of being liquidated, avers Burke, who notes that the holders of the senior tranches of these deals, mostly the large banks BTW, are forcing liquidation and wind up of these deals. In this case, BTW, “skin in the game” includes effective control over the CDO by the sponsoring bank. Mary Schapiro et al at the SEC please take notice.
That’s a problem, of course. $480 billion is a big number. But if these were carried at somewhere near actual trading value, nobody would care. The problem is that they’re not:
What is really scary is that most of these CDOs, which are carried by many banks as “Level Three ” assets under the FASB fair value rule, are showing virtually no recoveries. Like 5 cents on the dollar for the senior debt and nothing, nada, bupkus for the other tranches. So we wonder: Why aren’t the people who created and sold these securities going to jail? The sponsor list in the Ramius report reads like a “who’s who” of Wall Street, both the Buy and Sell Side firms.
Got it? $480 billion worth of “assets” that have an actual value of zero. Well, ok, a nickel on the dollar – for some of the tranches. The rest is zero.
The banks are claiming this is all “good paper” and carrying it as an asset at or close to 100 cents on the dollar, or “par”.
We can’t think of a better example of the futility of Fed policies like quantitative easing than to see large and regional banks pretending that an ABS or CDO is still worth close to par, when in the secondary markets this paper is being auctioned for almost nothing. The Fed has window dressed the accounting for banks in 2009, while the actual market for this paper sees sponsors forcing acceleration and liquidation of deals.
It’s called legalized accounting fraud, and I’ve been hollering about it for three years. As the loss severities have continued to climb and the impact accelerate into other areas of securitized debt, the so-called “regulators” have scrambled to find new corners of the carpet to allow the banksters to hide the truth under.
No rational buyer wants to pay book value for the average large bank today because most sophisticated M&A professionals know that disclosed loss rates on loans and securities are currently understated. Our guess is that due to poor disclosure, price manipulation by the Fed and regulatory forbearance, current charge-off rates in the US banking industry are understated by 1/3 to 1/2 of the true economic loss.
Yep. None of the balance sheets you find today in a firm with financial exposure means a thing. It gets even worse when you start adding back in off-balance-sheet garbage – and the big banks have literal hundreds of billions of dollars of that junk out there too – each.
IRA also hits on something else I’ve been raising cain about:
Given the lack of true, private economic activity in the industrial world, at least excluding government stimulus, the prospect of rising interest rates may spell big trouble for equities generally and for the financials in particular in the coming year. Eventually the industrial nations will have to default upon and/or restructure their public sector debts, a deflationary process that suggests a prolonged period of low or no economic growth and more shrinkage among financials.
Looks like someone has figured out the essence of this chart, although they probably did it on their own (it’s not rocket science folks):
Institutional Risk Analytics is one of the few analytical entities I’ve run across that, in my opinion, nearly always “gets it right”, and this is no exception.
Oh sure, we can play “Fed Bubble Games” for a while, but in the end the cash flow always wins. No auditor will let you carry a defaulted CDO that is wound up and no longer exists at Par, no matter how loud you bleat.
What many people in the markets today believe is a “successful” execution of “extend and pretend” is to be proven woefully incorrect. Defaulted paper – or paper for which there is no reasonable recovery and default is statistically likely (or worse) can be hidden in “Level 3” buckets or off-balance-sheet vehicles (enabled by a government that finds accounting and control fraud to be crimes in name but refuses to prosecute) only until acceleration and/or liquidation subsequent to default destroys the cash flow. Then that particular security, whatever it is, effectively ceases to exist and the loss that has been delayed comes bursting onto the stage ensconced in bells, whistles and a balance-sheet-destroying holesaw.