Goodbye Non-Agency Securitization, plus Thoughts on TALF, by Victor Hong

March 10th, 2009 · No Comments


Non-agency securitization, especially complex, will never return during our careers..

An underlying problem of the bailout programs is not just moral hazard, but publicly sponsored contract abrogation. Examples start as homeowner defaults, of course, but grow to include foreclosure moratoria and the statutory nullification of securitization pooling-and-servicing agreements (PSA), particularly their provisions for servicer loan-modification limits and bankruptcy loss carve-outs.

Because bankruptcy loss carve-outs have been eliminated, subordinate and mezzanine RMBS tranche investors must now bear a much greater proportion of default losses than they contractually had ever accepted. All this is eminent domain, essentially, where private individuals are unilaterally and publicly forced to suffer ex-post losses without adequate a-priori compensation.

The concepts of asset protection and contractually scheduled cashflows are gone.   Non-agency or highly structured securitizations are dead, and unmarketable.   The change is secular, not cyclical.    The rest of the story is advising investors how to extricate themselves from this deliberate train wreck, and never look back.

The unavoidable impact will be less and costlier credit for the entire economy, whether on the consumer or business side. What seems a free lunch becomes the most unaffordable meal which one can ever eat.


Thoughts on TALF:

As additional TALF implementation details appear, there seems little if any clarity about the core matter of valuations. How will the Fed and each investor agree upon the fair value for funding a specific ABS?  Indeed, suppose that two investors submit separate holdings of an identical bond, where one has valued it at 65:00 but the other at 95:00? Such likelihood is not remote, given the large outstanding principal size of many TALF-eligible ABS. Presumably, both investors must legally attest to supportable fair-market marks, when borrowing from the Fed on a term, non-recourse basis. Otherwise, if mark-to-market investors are broadly and knowingly authorized to assign materially divergent prices to identical (or even closely comparable) bonds, that would defeat the key TALF goal of promoting transparent market liquidity.

My suggestion is for the Fed to post publicly the lowest, median, and highest prices where it has TALF-funded each CUSIP, and require that any investor who funds an additional holding of that CUSIP must do so at the lowest price. This would protect the Fed and ultimately taxpayers, while also promoting the price discovery, financial-statement accuracy, and market re-liquidification which all parties claim to want.

Victor Hong may be contacted through Bill Coppedge.

Tags: Mortgage Market

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