The New York Times reports that Greg Lippmann, made a star by author Michael Lewis in The Big Short, for making millions on the housing collapse, is now taking the other side of the bet and buying mortgage backed securities.
On the surface one wonders what he’s thinking. As Azam Ahmed writes,
Take one security, JPALT 2006-S1 1A11, which was built from Alt-A loans, or mortgages that required little documentation verifying a borrower’s income.
On the surface, the numbers are not encouraging: of the 799 mortgages underpinning the bond, many in foreclosure-heavy California and Florida, about 21 percent are more than 60 days late on payments.
The annual default rate is about 7 percent, and of the homes sold out of foreclosure, investors take a 54 percent hit, according to data from Bloomberg. On average, about 5 percent of the homeowners refinanced their mortgages before they were due over the last 12 months.
However, JPALT 2006-S1 1A11 is trading for 70 cents on the dollar, making the security a compelling buy. An investor can still make more than 5.4 percent even if defaults increase, according to Ahmed. And even a slight improvement in the default rate would send returns as high as 8.7 percent.
“Price is a wonderful thing,” said Chris Flanagan, an analyst with Bank of America Merrill Lynch. What was “toxic” at 100 cents on the dollar is compelling at 70 cents.
When prices are allowed to adjust, markets clear. Imagine, if wages were allowed to fall or banks and the GSEs were allowed to fail.
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” When prices are allowed to adjust, markets clear. Imagine, if wages were allowed to fall or banks and the GSEs were allowed to fail. “The above belief is on a par with, “If God had wanted us to fly he would have given us wings.” Both sound wonderfully logical but in truth things that fall do not necessarily get up. Just ask the Roman Empire.
Mike Deignan
“If God had wanted us to fly he would have given us wings.”
How does that sound anywhere near logical? It is a dogmatic statement from a cave dweller who has to painstakingly construct a sentence from a very limited set of unclear concepts. It cannot be used for anything.
”When prices are allowed to adjust, markets clear.”
That however, is a statement that is clear as day. It says something about the real world. In the same way as “if you put a resistor across a voltage differential, then heat will be generated”. The conterfactual
”When prices are not allowed to adjust, markets [most probably] won’t clear.”
explains misallocation of resources, overstocking, housing boom and busts, unemployment – and just maybe the fall of the Roman Empire.
The same Roman Empire that brought about its collapse through currency debasement to finance its over the top and overstretched expenses? Sounds like another stupid mantra to justify statist interference in the economy, further divorcing it from reality.
“If God had wanted us to fly he would have given us wings” doesn’t sound logical at all. It implies some sort of higher intelligence setting up a Plan for the rest of the world to follow, one inferred by the speaker by current conditions. On the other hand, “When prices are allowed to adjust, markets clear” is a factual statement. It is an emergent property of human interaction.
The Roman Empire didn’t fall because they allowed prices to adjust properly. In fact, they tried all manner of tricks to prevent just that in the latter days of the Roman Empire, including the use of an inflationary monetary policy to prop up “too big to fail” legions and mega land owners. You’ll never see a nation destroyed because they allowed markets to work. In fact, you do see backwaters and boondocks becoming powerhouses when they do allow market forces to work properly.
Wow. Apparently, if G*d (government) had wanted people to succeed, it would have granted them a free market.
The Roman government spent centuries depleting the savings of the its people to support armies fighting on the frontier. Because of the lack of food, people were forced to drop out the high order professional occupations (like architects and artists) and into low level (immediate consumption) occupations like farming. Eventually, taxes became so high that the farmers had to be bound to the land and could not flee. The Roman government turned a highly advanced civilization that had taken thousands of years to develop into a pre-industrial third world basket case. The result was a thousand years of misery and serfdom for our ancestors (assuming ‘we’ are of western european descent).
Before the Roman government got carried away with policies that are (shockingly) still proposed by both Republican and Democrats as if they are new ideas, the Etruscan civilization had constructed wonders that were not matched until the 19th century!
Mike,
I tried to call and ask the Roman Empire, only to find that it doesn’t exist anymore.
Since I’m not smart enough to know what the Roman Empire would tell me to make me believe that prices should NOT be allowed to adjust, perhaps you could enlighten me. Perhaps Rome fell because they didn’t prop up the housing market, or perhaps their minimum wage rates where too low? Or maybe they instituted a “right to work” law and that sent them into an unrecoverable economic “race to the bottom” tailspin?
Please forgive my naivete, but I went to public school all the way through undergrad and took classes that would help make me valuable to employers in the productive part of the economy, so I didn’t have time to take any classes on the Roman Empire.
Chris
It is no coincidence that the debasement of money in Rome was followed by the collapse of the republic.
Chris:
“Please forgive my naivete, but I went to public school all the way through undergrad and took classes that would help make me valuable to employers in the productive part of the economy, so I didn’t have time to take any classes on the Roman Empire.”
My wife and I had to take Latin classes in school. She contends that this was worthless. For my part, reading this site, it allows me to understand what Post hoc, ergo propter hoc means!
BTW
“things that fall do not necessarily get up. Just ask the Roman Empire.”
I think this is a valid point. (Mike said nothing about what caused the fall). Japan has not yet recovered, even after 20 years. Bank’s mortgage policy is essentially “I’ll wait until prices go back up”. (Extend and pretend, delay and pray).
Incidentally, what we might be missing here is that there may be a government bailout (handout).
People who buy these mortgages way below par may benefit in the future.
“Incidentally, what we might be missing here is that there may be a government bailout (handout).
People who buy these mortgages way below par may benefit in the future.”
Bingo. That’s what I was thinking.
If a bond is discounted until it pays an above market interest rate on your investment, plus whatever you, personally require for taking the risk…
Why not?
It’s a better bet than overpriced agricultural land.
Thank heavens that your big zero hasn’t taken the Irish solution, where the Irish government has promised the bank bond holders that Padraig and Naimh O’Taxpayer will pay them 100 cents in the Dodo.
ps
Did I see something last week about bank of China lowering bank reserve ratios? If so, the big bust is getting closer.
For what it’s worth, economist Jeffrey Rogers Hummel does just that in a recent piece.
Oh, and, the Roman Empire? Wow.
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