Category Archives: Market Trends

Lawsuits, arbitrations and regulatory actions are on the rise against Wall Street firms for their active participation in the auction-rate securities market.  Many experts contend that Wall Street is going to have a tough time defending the impending flood of claims.

One reason why Wall Street is likely to be taken to task is that the firms were so actively engaged in this segment of the market.  The firms created these products as a way for municipalities, charities and others to raise money for long-term periods at short term rates.  Not only did the firms facilitate the creation of these products, they were a crucial player in the auctions themselves.

Prior to the last several months, in the event that interest in an auction was not sufficient, Wall Street firms would step in and make a market with their own bids on the securities.  This was an important characteristic of the auction-rate products.  However, recently when the credit crisis began causing the auctions to fail, Wall Street did not step up to the plate and make bids.  As such, they left investors holding these products with no market and left issuers paying higher interest rates.

According to a recent Wall Street Journal article, Auction-Rates A Legal Tangle, by Amir Efrati and Liz Rappaport, one reason Wall Street is facing such a nettlesome legal problem is because the victims in these cases are easy to identify and are more sympathetic than the institutional players who have suffered losses in other mortgage-related investments.

It is expected that more and more legal actions will be initiated as investors tire of waiting and hoping that the markets will once again become viable.  Now that many firms are no longer pricing these securities on customers’ statements, investors are taking action to protect themselves against loss and seeking to recover damages caused by the inappropriate marketing and sale of these securities.   

Bloomberg is reporting that Standard and Poor’s has lowered its assumptions for how much money investors will recover after defaults of mortgage related collaterized debt obligations.  Many view this as a sign that S&P may be preparing to add to the record number of downgrades already present.

Mortgage-linked CDOs have been the biggest source of more than $320 billion of asset writedowns and credit losses since the beginning of last year.  These writedowns have come primarily from classes once rated AAA or Aaa. 

According to Brian James, a partner at Link Global Solutions, “further rating-agency action will cause banks who hold hte majority of AAA bonds to re-evaluate their strategy.  So far they have been more comfortable writing down their positions in hopes of better recoveries.”

A statement released this week from S&P announced that the most senior bonds from CDOs originally rated AAA should recover 60 percent of principal owed, while securities rated A or lower will get nothing.   

One possible outgrowth of these reductions could be an increase in a secondary market where holders are forced to entertain the bid side of the market. 

According to S&P, their structured-finance ratings only reflect the odds that investors will receive timely interest payments and the return of their principal by the debt’s maturity date. 

The Wall Street Journal is reporting that Merrill Lynch & Co. is expecting to announce $6 billion to $8 billion in new write-downs this week.  This would bring Merrill’s total write-downs since October to more than $30 billion.

The write-downs have been caused (largely) by the subprime, CDO and credit crisisses.  But what is most interesting about the latest WSJ piece is that it appears Merrill was continuing to create new mortgage securities well after the risks of such securities were known.

It can be argued that Merrill was so taken by the large profits being generated by the creation of these new securities that even after it had become common knowledge that the risks of these products were greater than anticapated, Merrill did not relent in packaging and selling these securities to investors.  Now the SEC is investigating whether Merrill should have told investors earlier about the failing mortgage business.

The average individual investor can learn quite a bit from this story.  Namely, Wall Street and its brokerage residents often work in a vacuum.  They are all too frequently blinded by short-sided profit motives.  How else can one explain why Merrill Lynch kept digging itself into a subprime hole well after the hole began flooding?        

In an article in today’s Wall Street Journal, Liz Rappaport and Karen Richardson report that securities tied to student loans might be succumbing to the credit crunch.

The Wall Street players that bundled and sold investments in subprime mortgages also packaged student loans into similar investments.  According to the WSJ, auctions of these securities conducted by Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and Citigroup Inc. have failed to generate investors’ interest, leaving roughly $3 billion of securities without investor buyers.

In the past when demand was weak, the banks would step in and purchase the shortfall.  However, given the recent events relative to the subprime collapse, banks are already overburdened with other types of investment products they are trying to get off their books.  As a result, the auctions for the student loan products are failing.

These failures serve as an indicator that investors are growing reluctant to invest in these complex products tied to loans.  The fear is that valuing these products is difficult and that, like the subprime loans, these products will too experience declines in value.

When these auctions fail, the securities are left in the hands of investors who already hold them.  The result is that interest rates get reset.  The impact of this financial phenomenon is that students will likely see higher costs associated with their loans.

As this story illustrates, the fallout from the creation of complex securities by Wall Street continues to trickle down to Main Street.  It would appear that no credit program is beyond the reach of the current crisis.   

 UBS announced today that it would be writing-off $14 billion in losses due to the declining U.S. housing market.  In addition, UBS announced it would post a net loss for 2007.

The New York Times is reporting that $12 billion in losses relate to positions in the U.S. subprime market and an additional $2 billion on other positions related to the U.S. residential mortgage market.  

To date, major banks have announced over $135 billion in write-downs due to the troubled housing market and subprime lending crisis. Those numbers are expected to grow. UBS joins Merrill Lynch, Morgan Stanley, Citigroup and others in experiencing significant write-offs over the past several months.   

The cause of these write-offs are largely collateralized debt obligations (or CDOs). These very complex securities are created when pools of debt, often tied to subprime mortgages, are packaged and sold to investors. While many of these products have fallen into the portfolios of individual and institutional investors, some have remained on the books of the world’s largest banks. It is only a matter of time before the losses that are being reported daily by the banks are felt by investors as well.