A perhaps naive question about securities.

March 25, 2009 2:09 PM

Thanks to NPR, I understand that securitized mortgages are bundled together and divided into traunches, and that this is bundling and dividing process is what makes these securities so difficult to deal with. Is there no way to "reassemble" the traunches and de-securitize the mortgages? It seems like that would make valuation easier to determine, and help with isolating bad mortgages/ investments.
posted by boo_radley to work & money (5 comments total)

tranche as in slice in French

And no not really because you would need the guys who are still unlikely to take losses in the structure being willing to share in the pain of the lower tranches and the way the contracts are written the guys at the top call all the shots.

It wouldn't really accomplish anything. Bad assets are bad assets. The things that are questionable in a CDO of RMBS are still questionable in an RMBS (Default probability and recovery). The only difference is how the cash flows the bonds payout get divvyied up amongst investors.
posted by JPD at 2:27 PM on March 25

I am not an expert, but I would think it is because the securities backed by these mortgage assets have already been sold. The people who own a piece of the various tranches (french for slice, as in "Je voudrais une petite tranche de MBS, s'il vous plaît") are due interest payments. You can't unwind the securities back into mortgages without paying off all the bond holders.

One way to get rid of the bonds is go ahead and default, but then the credit default swaps (CDS) that were bought as a hedge on those bonds in case of default would come due, and everyone knows there is not enough money backing those CDS contracts. So the companies that wrote the CDS would have to go bankrupt or get a bailout (e.g. AIG). And the companies that were counting on the CDS as a hedge would not get their money, so they would go bankrupt....

The last thing anybody wants is for those bonds backed buy securitized mortgages to default, because that could bring down the whole house of cards.
posted by csw at 2:41 PM on March 25

The CDS for the most part were only written on the Supersenior Tranche - so if they were going to default in any circumstance the whole structure is so shot already that there are already no other tranches - they've been wiped out as the supersenior holder shut down the cashflow.

Additionally the CDS are not fungible. If you broke up the CDO they were attached to then they would automatically cancel.

The CDS counterparty risk issue as it relates to valuing RMBS based CDOs is not material. The fact that these tranches already trade at less then par implies no one thinks the insurance is any good already.

The finance media has once again totally dropped the ball.
posted by JPD at 2:50 PM on March 25

OK JPD, since you clearly know something about the subject, here's a question for you - Ignoring moral hazard, would it be cheaper for the govt to guarantee every residential mortgage in america than to keep bailing out the insurance companies and the banks? Is the total value of all the mortgages that are likely to default less than what they are likely to spend propping up these companies?

If the residential mortgages cannot default, then the CDOs are worth more, and the CDS will not be triggered, and everybody's happy, no? At least until the CRE market fails, or credit card defaults rise too high, or...
posted by csw at 4:22 PM on March 25

you can't waive away moral hazard.
posted by JPD at 5:25 AM on March 26