Thursday, November 08, 2007

Structured Hybrid Investment Tranches

As our small legion of regular readers knows, HazZzMat occasionally ventures into the realm of investment arcana due to Wonker's experience as a stockbroker many years ago and his continued involvement in the currently frustrating world of investments.

As any sentient being knows right now, the markets are being mightily roiled by the chaos caused by mass quantities of subprime mortgages re-setting, defaulting, and destructively rippling through the system. We won't get into the details, but if you're in stocks, you're not having too much fun right now.

A major part of the current mess is that most institutions who issued these teaser-rate subprime mortgages—mortgages that are now re-setting and driving mortgage holders into foreclosure at an accelerating rate—either sold them off to mortgage servicers and/or other institutions who sliced and diced them into little pieces, put them in bond-like packages, and sold them off to other lending institutions, hedge funds, private investors, whatever. Again, not to drill down too deeply, these packages have acquired various names like CDOs, SIVs, etc. (Note: Google this stuff if you're really interested.) All the lay investor needs to know about these package deals right now is that, since significant pieces of these artificial constructs are collapsing, no one really has a clue as to what they're worth anymore.

Hence the ongoing market panic. Your entire balance sheet becomes suspect, and perhaps several quarters of booked earnings may now, in fact, turn out to have been smoke and mirrors. In other words, bottom line, your Chief Financial Officer (CFO) no longer has a clue as to what your company, earnings, etc. are currently worth, and several previous quarters' reported earnings may very well have been intentionally or unintentionally bogus. This is certainly not what anyone, ranging from company officials, to institutional, international, or individual investors want to hear. "Oh, those bonds I sold you. I don't have any idea if they're worth anything now. Have a nice day."

Following this stuff is a brain buster unless you're a CPA which I am not. And even legit and highly skilled CPAs are absolutely confounded when looking at these hybrid instruments. But this is why I subscribe to a few pay services whose gurus have been pretty good keeping me on track. Most useful to me at least is Decision Point, which is run by a retired air line pilot, Carl Swenlin, and offers some of the best and most useful technical info around. Carl occasionally posts excerpts from other pay-per-view services as a way of offering further market insights while cross-marketing those he thinks his users might find useful if they subscribed.

One of these services is Alan Newman's "Crosscurrents." The Crosscurrents excerpt currently posted on Carl's site has perhaps the nicest, pithiest explanation ever of the mess I just outlined for you above, and introduces an acronym that provides us with an excellent handle on precisely what we're dealing with here:
We have long argued that the growth of indexing of U.S. stocks is destroying pricing efficiencies, since indexing tends to underrate fair values and overrate poor values, according to the time tested methods of security analysis. In the same fashion, the continuing rapid growth of derivatives threatens to understate overall systemic risk by securitizing literally everything, the bad along with the good. The world of CDOs, SIVs and most recently M-LECs is well on the way towards the creation of Structured Hybrid Investment Tranches (SHITs). All of the former are suspect. We fully expect to someday be buried in the latter.
I think Alan's conclusion is about right, don't you? Meanwhile, don't miss today's exciting Wall Street action which will feature yet another round of opaque Ben Bernanke testimony interpretations.

Carl's and Alan's services, as I said, are pay per view so I can't give you live links. However, I don't think Alan will mind my short excerpt above, as I think it deserves a wide airing amongst frustrated individual investors. If you want more info on Carl's Decision Point, click on the link earlier in this post. And if you're interested in seeing what Alan has to offer in Crosscurrents, just click here.

Oh, and watch out for the SHIT.

1 comment:

Anonymous said...

Worked in a banks for a while myself, and while the lingo sounds awfully complicated, so do the various "systems" of horseplayers, to remarkably similar ends.

Bonzaga the Banker