by NewstraderFX
First, I would say that the consensus in the market is that a rate cut in the target rate is a given and the possibility of a surprise move before then is very much on the table. Please be sure to see my article on FF: http://www.forexfactory.com/showthread.php?t=43243
I want to expand on that article here, because it relates to exactly what we should be looking for in the market as signs of stabilization in the CDO and therefore in the commercial credit markets in general.
The key is that these obligations can now be used as collateral on a revolving line of credit from The Fed. Remeber what a CDO really is: it's a product that is created by an investment bank and sold to investors such as big pension funds, hedge funds etc. Mortgages are bought from lenders such as Country Wide. These mortgages have different credit ratings attached to them which could be anything from AAA to sub prime. Each category of rating is called a "tranche". By bundling the tranches together, theoretically the risk is spread and therefore the investment is safer. As with any other bond, interest and principle payments have to be made on the CDO's, although exactly what they are is not generally available.
It was the sub prime tranche (and later the Alt-A) that went bad. Now that a revolving line of credit has been made available in theory it should be easier to obtain money to make those payments. (It should also make the writing of new mortgages easier, because the previously written mortgages can be used as collateral for the new ones). In my opinion, investment banks will want to make those payments because their credibility is at stake. Once the scheduled payments are made, the CDO holders should be less inclined to sell.
This is essentially the stabilization process that should be occuring and we should be acutely aware of any news regarding this as it will be very supportive of the markets in general.
1 comment:
Below is a small explanation about CDO's and risks related to them Matt gave me a few days ago. It cleared up the issue for me a bit.
RISK REPRICING
well the basic story is that mortgage lenders like Country Wide financial work much differently then the old-fashioned banks that people used to get mortgages from
they are not depository institutions like banks-so they have to go out and get money in order to make loans
and the way that they do this is by constantly writing new mortgages and then selling them
to investment banks etc
what an investment bank does is repackage all those mortgages-which were written with different levels of risk
sub prime being one level of risk
and there are a few higher ones also
the investment bank "packages" a bunch of these mortgages into a CDO
within that CDO are mortgages with different credit ratings
and that's the key because this spreading of the risk is what makes them safer
plus up until recently-the collateral behind these CDO's-the houses-had done nothing but increase in value
think of how nice it is to collateralize a loan with an asset that increases in value!
on top of all this-because corporate profits have been so good for a long time
the cost for corps to borrow have been very low
and the price of insuring default-the credit default swaps-was very low
that's part of what it means when you hear that risk is being re-priced
the price of risk was-in the view of the central banks for sure-way too low
one problem with the CDO's is that they are not exchange traded instruments
they are OTM instruments
so they are not liquid
like US debt for example
but no-one cared
they had made so much money for so long
hedge funds get in trouble because they use too much leverage to make investments
and when they don't hedge
hedging eats into the profits-when things are going well
it's like insurance for your car
so in the view of many-and very likely the central banks-what is happening now is a re-pricing that needs to occur
and that leads to another term-the moral consequence
is it moral to cut rates if people made bad investments?
when the "real" economy does not require a rate cut
actually-the best thing for the long term health of the economy would be if the fed did not have to cut rates-unless the real economic fundamentals indicated the need
which they do not
at this time
the problem with the market now is that all that CDO paper has not been marked to market
no one knows exactly what they are worth
what they are worth now is next to nothing because none can be sold at this time
Post a Comment