More Toxic Structured Finance Securities are on the Way to Market
One of the causes of the financial meltdown has reappeared, according to a recent MSNBC.com/AP article entitled “Wall Street’s new old idea: Mortgage securities.” The problem to be solved is what to do about the hundreds of billions of dollars of enigmatic, high-risk securitized mortgage pools that threatened (and some say still threaten) to bring down the global economy. The solution being developed by Wall Street is something called “resecuritization of real estate mortgage investment conduits” or “Re-REMIC” for short. If this remedy sounds a bit like “the hair of the dog that bit you,” it is.
The ingredients for this cocktail are repackaged mortgage-backed securities (“MBS”) of varying credit-worthiness (ranging from low-risk to high-risk), a risk-shifting agreement by the holders of the high-risk MBS that the holders of the low-risk MBS will get paid first, and, most importantly, a AAA rating for the low-risk MBS that allows them to be sold to pension funds, insurance companies and other investors that are required to hold only top-rated investments. The high-risk MBS will be sold for pennies on the dollar to hedge funds and others willing take a high risk for a potentially high reward.
“It actually makes a lot of fundamental sense, says Brian Bowes, the head of mortgage trading at Hexagon Securities in New York. “It’s taking a bond that doesn’t necessarily have a natural buyer and creating two bonds that might have a natural buyer for each.” “There’s no voodoo going on here. It’s just math,” adds Sue Allon, chief executive of Allonhill, which analyzes and values hard-to-value investments.
As the article points out, however, there is a real risk that, if the housing market slips more, even AAA-rated MBS may lose value. In July, 2006, average home prices in the United States reached an all-time high as reported by the Standard & Poor’s/Case-Shiller housing indices. Beginning in August, 2006, average home prices began to decline and continued declining each month thereafter until May 2009, which there was a slight increase, approximately 0.5%, reported. The point is that we do not know whether housing prices have stabilized. With high unemployment, there is a real risk that housing prices could slip further.
There is also risk in relying on the rating agencies to provide meaningful ratings. See our July 16 blog, “Wall Street Firms Still Don't Get It - They Continue to Sell Toxic Securities as AAA Investments.”
Wall Street investment banks are also turning collateralized debt obligations (“CDOs”) into RE-REMICS, and that has some observers (who are OK with turning MBS into Re-REMICS) worried. “I think that’s trouble,” Allon said. Allon explained that CDOs are already complex, and repackaging them into Re-REMICS makes it even more difficult to determine the value of the securities.
Proponents say that Re-REMICS could work, and it is different this time because investors know what they are buying. But the more creative Wall Street get, the more difficult it is for even institutional investors to know what they are buying. The more obscure the concept, Allon warned, the more likely the deal has gotten too creative.
Page Perry, LLC is an Atlanta-based law firm with over 125 years collective experience representing institutional and individual investors in securities-related litigation and arbitration. For further information, please contact us.
