When Wall Street comes up with a good idea, they overdo it until the system chokes on the product they created. After the market failure, the system becomes more sophisticated and risks are priced better.
The ABX.HE indexes were created to have a uniform way of trading tranched subprime mortgage credit on a consistent basis. This would allow parties to go long or short, and in greater volume than the underlying cash market would support. They started with the 06-1 deal, which reflected subprime mortgage deals from 20 different originators from the second half of 2005. They have gotten as far as the 07-1 deal,which reflected subprime mortgage deals from the same 20 originators from the second half of 2006.
Well, now what? Many of those originators are gone, and most of the rest have scaled back massively. Will there be an 07-2 deal? In some ways, I wonder if the existence of the ABX.HE deals didn’t help to create part of the problem, in that the 20 originators had to come out with at least one deal of a certain size every six months. Being in the index would mean cheaper funding, so an originator would want to do that if possible.
I don’t see how the ABX.HE 07-2 gets done, and honestly, the system might be better off if it doesn’t get done. The existence of subprime mortgages encourages some people to take on onerous debt that they would be better off not incurring. Anything that encourages more subprime lending (and other high interest forms of debt) is in my opinion, a bad thing. Let people learn to defer their gratification, put more money down, and on the whole, they and the whole nation will be better off.
Although I have no where near your depth of knowledge on how levels of credit risk trade it appears that the level of complexity caused by derivatives from the actual loans is so great that no one really knows the level of equity backing the risk trade-offs between parties. (This is no secret just perusing through Real Money). From what I have read the actual loans sold off by Accredited Home Lenders appear to have been discounted by 6% and they were required to put aside capital for projected writeoffs on that loan pool. That certainly stressed Accredited’s balance sheet; but it is far from a catastrophic failure of the value of the actual loan assets. Periodically I run into investors that do “small sub prime loans” on 10 to 20 properties and do pretty well; I’ve also run into people that in the past have done small scale equipment leasing/financing; but the hunt for yield and Wall Street have pretty much ended that type of business.
As an aside in the vehicle delivery business I also run I would welcome the cut-off of home equity and other financing as it would kill off some of my competitors and I could charge more per mile! (we have no debt; the bank is too big of a hassle with a regard to receivables). Easy credit has allowed small operators to work from their kitchen table (basically contract drivers are paid up front for delivery and the company has the inevitable 30 to 60 day waiting period before getting paid); but insurance premiums (rising) and the customer requiring frequent proof of coveragee should squeeze tose competitors out of the market. I hope not too off topic. Great updates on the blog david.
Thanks, Paul. We never know who is swimming naked until the tide goes out.
Do we know where to get historical pricing on the ABX-HE?
Naveed, try here. It wont give you numbers, but you can see historical graphs.