Subprime Mortgage Credit Derivatives by Frank J. Fabozzi Subprime mortgage bonds and ABS CDOs have become the biggest credit and risk management failure in history. Their story is one of how a small, inconsequential part of the mortgage market grew into a monster large enough to shake the very foundations of the U.S. financial system. It is a story with some elements that are old and some that are new, and it is a story that is far from over. In the meantime, analysts and investors are left wondering about how the $700 billion of outstanding subprime securities should be valued. Written by an expert team of practitioners from UBS—the world's largest wealth manager and a top tier investment banking and securities firm—and Frank Fabozzi of Yale University, Subprime Mortgage Credit Derivatives offers readers the best strategies and risk management tools for dealing with today's growing and currently volatile subprime mortgage credit derivatives market. The authors examine the factors that determine default and prepayment risk, and in the process outline the origins of the current subprime crisis. They look at how the three forms of subprime mortgage risk—cash, single name ABCDS, and the ABX—differ and what drives their relative spreads. And they examine the salient features of the excess spread/overcollateralization structure used on most subprime securities since 1998, showing how even a small change in the prepayment rate or default rate can cause a major shift in cash flows, which in turn can have a major impact on valuations. Explaining how an understanding of ISDA CDO CDS documentation is critical, the authors dissect this document into its working parts and explain each—sorting out the five credit problems the documentation recognizes can happen to a CDO and the two consequences for which the documentation provides. They also provide a simple model that will prove useful in predicting which lower quality bonds will write down and when the write-downs will happen. For all those who want to go long or short these derivatives—as well as understand more about the market pricing of cash underlyings—Subprime Mortgage Credit Derivatives will prove to be an invaluable resource. Now available for pre-order.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aR0DO3lgYJuw&refer=home That would make it $15 billion on the year and $27 billion over a two year period. All I can say is WOW...

http://www.reuters.com/article/bankingFinancial/idUSN0538798120080505 We've already seen a handful of NY State Supreme Court subprime related cases, it appears they are only the start of it.

http://network.nationalpost.com/np/blogs/tradingdesk/archive/2008/05/06/dumb-subprime-lenders-and-investors-should-not-get-help-warren-buffett.aspx “Capitalism without failure is like Christianity without hell,” Mr. Buffett said. He added that “lenders and investors who were dumb enough to deal in subprime mortgages should not receive any special help,” but if homeowners were deceived about the terms of an adjustable mortgage, they should be helped. I completely agree, but I'm still curious what happened with his plan to start a financial guarantor company. Originally when AMBAC and MBIA were taking heat for their subprime exposure and writedowns there was talk of Buffett bailing one out or starting his own under the Berkshire Hathaway name. Guess we will have to wait and see.

http://www.bizreport.com/2008/04/click_fraud_rate_up_year_on_year.html Click Forensics reports that click fraud is on the rise in Q1 2008 over the prior year period. At 16.3% in Q1 2008 it is higher than the first quarter 2007 click fraud rate of 14.8%. Even more alarming, Click Forensics reports [t]he fraud rate on third-party sites, such as ads placed through AdSense on non-Google websites, also rose from 21.9% in Q1 2007 to 27.8% in the first quarter of 2008.

http://www.charleston.net/news/2008/may/01/strengthen_identity_protections39193/ [A]ccording to etiolated.org, a consumer-advocacy group, only 21 percent of "data-loss" cases in our nation since 2000 have come from the federal and state government, with 40 percent traced to private businesses and 39 percent from educational, medical and nonprofit sources.

http://www.bloomberg.com/apps/news?pid=20601087&sid=ano45SuVp_3w&refer=home Some view the moves by the Bush Administration to increase the limits of guarantees by the Federal Housing Administration as not enough. Sheila Blair from the Federal Deposit Insurance Corp. (FDIC) suggests that: Congress should initiate a publicly funded loan program under which the Treasury Department would make loans to borrowers with unaffordable mortgages to pay down as much as 20 percent of their principal. Although I feel for those who legitimately were fooled by their mortgage terms, I do not believe that a bailout should be available to all subprime borrowers with high loan values and falling home prices. I would be interested in the stipulations included in the proposed subprime bailout.

http://bankimplode.com/blog/?p=68

http://www.reuters.com/article/bondsNews/idUSN2233380820080422 Falling home prices have made an increasing number of U.S. homeowners more vulnerable to default, they said. Nearly a third of subprime borrowers owed more than their home was worth at the end of last year, and that figure will double to 63 percent in 2009 It is interesting that borrowers facing these circumstances tend to walk away from their homes while continuing to make their credit card payments. Although falling home prices is one factor in this problem, many people forget most of these subprime loans were option ARMs. Most of the option ARM loans had low teaser rates that led not only to payment shock at the reset date but also allowed borrowers to defer payments that were added to the principle of the loan (negative amortization). The gamble made by most borrowers was that home prices would continue to increase by the same amount (or hopefully more) then the increasing principle of the loan. Since home prices fell and loan principles had been steadily increasing, the loan to property value (LTV) for most subprime borrowers has increased so significantly that the decision to walk away is becoming a legitimate option.

http://burnickblog.sovereignsociety.com/2008/04/is-wall-streets.html Here's another perspective on the Bear Stearns issue with the SEC. The primary focus on this is how the SEC had acknowledged Bear Stearns shady pricing methods for their CDOs but did nothing to stop them until the bail out. On a personal note, I have large issue with the concept of a tax payer bail out. Whether the government admits it or not, when the Federal Reserve backs these deals it is you and me that foot the bill if things go sour. We as taxpayers should not have to pay for their indiscretions that made them a fortune over the boom of subprime lending but has now led to their demise.

http://www.businessweek.com/magazine/content/08_18/b4082026894702.htm?chan=top+news_top+news+index_businessweek+exclusives I found this article interesting in that it points out how difficult it will be to get these executives for fraud without an email basically saying that they willfully provided valuations despite having knowledge that they were incorrect. What the article does not address is whether the action would fall under Sarbanes Oxley which would provide prosecutors with another means of pursuing these executives in court.

http://www.foxbusiness.com/markets/industries/real-estate/article/subprime-market-melts-shareholders-heated_574414_17.html Angry institutional investors of firms such as Morgan Stanley and Washington Mutual have become involved in changing the face of the board of directors. Shareholder activists such as Change to Win have campaigned against directors they believe would should no longer be in control. This type of active investing has been correlated with increased returns for shareholders. Research on programs such as CALPERs have determined that large institutional investors can see increased returns by spending only a small proportion of their fund's money in order to actively protect their investments.

http://www.navigantconsulting.com Navigant Consulting released today that in the first quarter of 2008 there were 170 cases filed. Of the 170 cases filed, borrower class actions and securities cases dominated the subprime filings with 79 and 44 cases respectively. Based on the explosion of federal subprime filings, Navigant expects that the total case filing "will soon surpass the 559 savings-and-loan cases of the early 1990s." For more information check out Navigant Consultings website.

http://www.forbes.com/facesinthenews/2008/04/16/rishard-fuld-lehman-markets-face-cx_md_0415autofacescan03.html I'd be optimistic too if I made $51.7 million during 2007.

http://online.wsj.com/article/SB120535743939031491.html?mod=djemalertNEWS The nation's top economic policy makers plan to release today their broadest blueprint yet for avoiding a recurrence of the credit crunch now threatening the economy. Their recommendations extend to nearly every niche in the credit markets -- from mortgage brokers to the Wall Street firms that package home loans into securities, to the credit-rating firms that assess the risk of those securities, to the regulators who police the system. Amid the housing market's deepening slump, mounting defaults by cash-strapped homeowners and an upswing in foreclosures have made investors wary of mortgage-linked securities and have made those securities increasingly difficult to value and trade. That's led to turmoil in global financial markets. "We aren't singling out any group of market participants, because...there were mistakes made by all," including regulators, Treasury Secretary Henry Paulson said in an interview yesterday, a day in which the stock market's euphoria over the Federal Reserve's latest initiative to free up the flow of credit gave way to some caution.