Friday, May 16, 2008

The worst mortgage securitization ever?

(Naked Capitalism) I'm sure readers know of other super turkeys, but Floyd Norris in the New York Times did find a prime example of crappy paper. Note that he limited himself to securities, so CDOs were not candidates for this Hall of Shame award.

The Merrill deal was a pool of seconds ("piggybacks"). Moody's noted that this type of loan was typically written off after serious delinquency, since they had little or no equity from the outset. Key terms of the Merrill deal per Norris:
Fewer than 30 percent of the loans were made to borrowers who provided full documentation of their income and assets. Many of the other borrowers probably lied about their income. Nearly all had borrowed the full appraised value of the home, either for the purchase or for refinancing, and it is possible that some appraisals were unreasonably high even before home prices began to fall.

One hates to say it, but so far, this sounds only-somewhat-worse-than-usual late subprime practice. But they we get to the doozy:
...the mortgages had rates averaging 11.2 percent. Yet investors who put up most of the money were willing to accept a floating rate of just 30 basis points — three-tenths of one percentage point — over the London interbank offered rate.

And this paper was sold institutionally....or at least some of it was. Remember, Merrill would up retaining the super senior tranches on later deals because it couldn't find enough suckers takers. And yes, super senior means AAA.

Moody's still rates this dreck as investment grade (barely), while Standard & Poor's cut it to junk, and has now ceased publishing ratings on this and similar instruments.

The amazing thing about an issue like this is at a large institution, you can't blame a deal like this on a rogue investment banker. A lot of people are involved in underwritings: the investment banking department, bond salesmen, traders, sometimes research. Pricing is a formal process. So this means a bunch of supposed professionals either got very high together or were subject to collective delusion.

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