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Cdos Are Worth Much Less Than 22 Cents On The Dollar

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Super-Senior Tranches of CDOs are Worth Much Less than 22 Cents on the Dollar: Another Ponzi Scheme of “Selling” Toxic Garbage with More Leverage

Merrill Lynch decision to “sell” a good chunk of its remaining CDOs at 22 cents to the dollar has been widely praised as the firm finally recognizing the full extent of its losses on these toxic instruments. This batch of $30.6 billion of CDOs was already marked down to $11.1 billion. Now with the “sale” of it to Lone Star at a price of 6.7 billion Merrill Lynch is taking another $4.4 billion writedown and “selling” it at 22% of the original face value.

But is this a market-based “sale”? No way as calling this transaction a “sale” is a joke.

Let me explain next why…

First, note that the secondary market for CDOs is now extremely illiquid and Merrill will provide financing for 75% of the purchase price, or a financing of $5.055 billion. That implies that these CDOs are worth much less than 22 cents of the dollar. These type of “sales” transactions – broker dealers “selling” their toxic waste at a discount and providing hedge funds and private equity funds with heavily subsidized financing for it – has going on for a while. That discounted “sale” price often ends up being much higher than the true value of the assets (and the ensuing writedown of the assets is smaller than the correct one) because of three reasons:

- the selling broker dealer is providing most of the financing for the transaction as this market is totally illiquid and no one could dump $11.1 billions of toxic and illiquid CDOs in such a market;

- the interest rate at which the financing occurs is often significantly lower than the appropriate rate at which this risk financing will occur. Merrill has not announced what are the terms of its financing of this deal and this leaves the serious suspicion of a heavily subsidized transaction;

- the collateral for this risky financing is the same toxic waste that was sold to a fund. In the case of the Merrill transaction if the market value of this $11.1 tranche (now priced at $6.7 billion) falls another 25% the collateral for the 75% financing (that is non-recourse as it is secured only by the collateral) will be worth less than the underlying assets and thus additional losses will be incurred by Merrill. In other terms, as pointed out by Bloomberg since “the financing is secured only by the assets being sold, meaning Merrill would absorb any losses on the CDOs beyond $1.68 billion”. Thus, in a extreme scenario in which the CDOs actually end up being worth zero Merrill will end up having sold them to Lone Star for 5.5 cents on the dollar rather than 22 cents. I.e. leaving aside the first loss of 25% taken by Lone Star all of the remaining credit loss is borne by Merrill.

continues:

http://www.rgemonitor.com/roubini-monitor/...h_more_leverage

To borrow Peter Schiff's analogy, not only are Merrill are trying to give themselves a blood transfusion from their right arm to their left... they're also offering themsleves as blood donors! Meanwhile the blood's on the floor and no one's got a mop.

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continues:

http://www.rgemonitor.com/roubini-monitor/...h_more_leverage

To borrow Peter Schiff's analogy, not only are Merrill are trying to give themselves a blood transfusion from their right arm to their left... they're also offering themsleves as blood donors! Meanwhile the blood's on the floor and no one's got a mop.

The article needs to clarify what types of CDOs are worthless

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Forgive me for not fully understanding the finer points of derivative structuring, but can someone explain to me in plain English how a CDO, which I understand to be a complex bundle of different credit graded mortgage, loan and other credit backed securities, be only worth 22 cents on the dollar?

To a simpleton like me that implies 78 percent of the loans backing the CDO have gone bad, i.e. the debt is unrecoverable, but as they are collateralised i.e backed by both the loan AND the security backing the loan such as the house, office block or car why are they writing these off at 22 cents on the dollar used to buy them?

It all smacks of panic and doesn't make any sense, someone, somewhere a few years down the line (probably the bank that originated them, lol), will buy these back, recover the assets and make a killing. Or have I got this all wrong?

Doesnt need 78% of them to go bad.

Its return they are looking for and if 5% of the capital is not coming back due to defaults, then that more than offsets the interest coming in from the good.

Furthermore, the rating has been proved to be false, and, probably more important, the insurance to back up defaults and therefore ensure a guaranteed return does not exist in sufficent quantity to cover.

The whole model was based only on ever rising assets ( houses). Many players didnt even consider a house price drop at all.

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Forgive me for not fully understanding the finer points of derivative structuring, but can someone explain to me in plain English how a CDO, which I understand to be a complex bundle of different credit graded mortgage, loan and other credit backed securities, be only worth 22 cents on the dollar?

To a simpleton like me that implies 78 percent of the loans backing the CDO have gone bad, i.e. the debt is unrecoverable, but as they are collateralised i.e backed by both the loan AND the security backing the loan such as the house, office block or car why are they writing these off at 22 cents on the dollar used to buy them?

It all smacks of panic and doesn't make any sense, someone, somewhere a few years down the line (probably the bank that originated them, lol), will buy these back, recover the assets and make a killing. Or have I got this all wrong?

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How much were these guys being paid for their expertise I wonder? :lol:

Don't worry, I'm sure that all the players involved are now queueing up to hand their bonuses back on grounds that they clearly made a mistake.

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http://www.guardian.co.uk/business/2008/jul/29/creditcrunch

Adding to the gloom in the banking sector, Lloyds TSB today reported a 70% fall in profits and took another £585m hit from the credit crunch. The half-year results kicked off the UK bank earnings season, with HBOS due to report tomorrow followed by Alliance & Leicester on Friday.

The news came two days after Merrill Lynch shocked the market when it moved to raise fresh funds to shore up its battered balance sheet, sold $11.1bn (£5.6bn) of toxic mortgage securities and took a fresh $5.7bn mortgage-related write-down — just 10 days after it slipped into the red and unveiled write-downs of $9.4bn.

As the first anniversary of the credit crunch approaches, total write-downs announced by the world's largest banks have ballooned to $274bn. Some estimates suggest that the total losses, related to US sub-prime mortgages and leveraged loans, could hit $1tn.

Citigroup $47bn

Merrill Lynch $46bn

UBS $37bn

HSBC $25bn

Lehman Brothers $17bn

Morgan Stanley $12bn

Royal Bank of Scotland $11.8bn

Deutsche Bank $11bn

Crédit Agricole $7bn

Bank of America $7bn

Wachovia $6bn

Société Générale $6bn

Credit Suisse $6bn

JP Morgan $4.9bn

Natixis $4.3bn

Goldman Sachs $3.8bn

Barclays $3.8bn

Bear Stearns $3.2bn

BayernLB $3bn

IKB $2.6bn

HBOS $2bn

Lloyds TSB $1.7bn

Washington Mutual $1.6bn

UniCredit $1.6bn

WestLB $1.5bn

Commerzbank $1.1bn

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http://business.timesonline.co.uk/tol/busi...icle4425782.ece

The banking industry will be forced to take hundreds of billions of dollars of further writedowns on mortgage-backed securities after Merrill Lynch sold $30.6 billion (£15.5 billion) of collateralised debt obligations (CDOs) for only 22 per cent of their face value on Monday, according to a leading US ratings expert.

Freddie Mac and Fannie Mae, the financial groups that underpin America’s housing market, will be hit worst as they are forced into a combined writedown of about $100 billion, the Egan Jones Ratings Company believes.

Mike Mayo, an analyst for Deutsche Bank, said that Citigroup would need to write down the value of its CDO portfolio by $8 billion in the third quarter, based on the Merrill sale price. At present Citigroup values the securities at 53 cents in the dollar, more than twice the Merrill sale price.

Merrill Lynch is among the biggest victims of the credit crunch and is selling high-risk assets such as CDOs, which are pools of mortgage bonds, in order to regain financial stability.

How can Freddie and Fannie wipe off $100bn when they don't even have that in capital?

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  • 401 Brexit, House prices and Summer 2020

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      • down 5% +
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