Did Chris Whalen Nail This Or What?

I’m continuing work on Doom’s unofficial transcript of AEI’s March 28th seminar on the Subprime Mortgage Crisis [1] as fast as MP3 and Professor Dvorak allow. This morning I was just finishing up the draft transcript for Chris Whalen’s presentation and, well …


Chris Whalen [0:49:49]: Imagine I’m a trader in a hedge fund. I own a bunch of CDOs that I’ve been buying for the last three years from our prime broker and other brokers who service us. I get my valuations for these products from those dealers. There are no public prices for these securities. I could call two dealers, and I’ll get two different prices. They’ll be widely disparate in many cases. But what I’m saying to you is that there is absolutely no way for an auditor or a manager of a bank or a mutual fund or a hedge fund to verify the value of these securities until you get a bid for them.

When you go back to the broker-dealer and you say, "Oh, Al, you know you said 115 over for that tranche 2 you sold us, what’s your bid in 5 or 10?" You’re going to find out that it’s going to be about 200 over. Or 250. Because this stuff is totally illiquid, and if you think of it from the broker-dealers perspective, what’s he going to do with it after he buys it from you. It’s just going to become dead inventory on his book. [0:50:43]

 

Wow! And remember that Whalen was speaking in late March. When I shared the quote with twist, she fired right back with the following quote from a Bloomberg piece from earlier today.[2]

"… Bear Stearns is liquidating holdings from one of its hedge funds because of money-losing bets in the subprime market, said three people with knowledge of the matter. The firm is seeking bids today from prospective buyers for about $3.8 billion of mortgage bonds, said the people, who declined to be identified because the plan isn’t public.

`Small’ Involvement

While refusing to confirm details of the fund’s problems, Molinaro acknowledged that it was facing problems. The poor performance of the fund is already reflected in the second- quarter asset-management revenue figures, which show that the fund’s performance had an “immaterial” impact on earnings, he said. The firm’s direct involvement in the fund is “small,” Molinaro said.

The 10-month-old Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund, which is down about 20 percent this year, had about $600 million of investors’ money and borrowed to increase its buying power, one of the people said. …"

It sure looks like Whalen know just what he was talking about eleven weeks ago.

 

________________________

Notes and References

[1]: "Mortgage Credit and Subprime Lending: Implications of a Deflating Bubble", Event, American Enterprise Institute & Professional Risk Managers’ International Association, March 28, 2007.

[2]: "Bear Stearns Profit Drops 10% as Mortgage Bonds Slump", by Yalman Onaran, Bloomberg, June 14, 2007.

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1 Comment for this entry

  1. John M. says:
    June 14, 2007 at 12:25 PM

    Linging Wei has now weighed in on this with a typically insightful effort.

    “Bear Stearns CFO says mortgage bond business ‘slowly improving’ “, by Lingling Wei, Dow Jones / MarketWatch, June 14, 2007.

    This rise in defaults has squeezed lenders and upset investors and, in turn, has led to a plunge in the issuance of subprime-mortgage bonds. In the first quarter, sales of such papers dropped 22% to $88 billion, according to trade publication Inside Mortgage Finance. Last year, Wall Street packaged and sold about $448 billion of subprime mortgage securities, according to UBS AG.

    In recent months, investors have shunned even mortgages boasting higher credit quality, including loans to so-called Alt-A borrowers whose credit records are deemed good enough to forgo proof of their claimed income or assets.

    Separately, faced with investment losses, a hedge fund managed by Bear Stearns is liquidating about $4 billion in mortgage-backed bonds to raise cash, The Wall Street Journal reported on Thursday, citing people close to the fund and traders who have been solicited to buy the bonds. The firm is seeking bids from prospective buyers Thursday. The paper said Bear’s own exposure to the fund, which has more than $6 billion in assets, is limited.

    A market participant familiar with the auction said on Thursday morning the bidders are likely to be mostly Wall Street dealers who are acting on behalf of their clients including hedge funds and other money managers.

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