Pricing illiquid bank assets

by on February 22, 2009 at 7:42 am in Economics | Permalink

Interfluidity has an idea:

There's another way to generate price transparency and liquidity for
all the alphabet soup assets buried on bank balance sheets that would
require no government lending or taxpayer risk-taking at all. Take all
the ABS and CDOs and whatchamahaveyous, divvy all tranches into $100
par value claims, put all extant information about the securities on a
website, give 'em a ticker symbol, and put 'em on an exchange. I know
it's out of fashion in a world ruined by hedge funds and 401-Ks and the
unbearable orthodoxy of index investing. But I have a great deal of
respect for that much maligned and nearly extinct species, the
individual investor actively managing her own account. Individual
investors screw up, but they are never too big to fail. When things go
wrong, they take their lumps and move along. And despite everything the
professionals tell you, a lot of smart and interested amateurs could
build portfolios that match or beat the managers upon whose conflicted
hands they have been persuaded to rely. Nothing generates a market
price like a sea of independent minds making thousands of small trades,
back and forth and back and forth.

Via Thomas Barker, here is an even more radical idea.

1 Sean Brown February 22, 2009 at 9:42 am

It makes sense but because of GAAP accounting, banks and politicians would not want to do this. Many, many banks would be shown as “insolvent” due to the fact that many, many Level-3 assets (mark-to-model) would move to Levels 1 and 2. The Level 1 and 2 prices would be almost certainly be lower than the current Level 3 values for assets held at sick banks like Citi and BoA. Therefore, the minute this market is set up, Citi and BoA become insolvent by GAAP standards, which would then require another bailout (or, hypothetically, liquidation).

2 Zamfir February 22, 2009 at 9:56 am

Sounds good, but isn’t the idea that (relative) amateurs would make up most of the market a bit naive? Presumably the big buyers would be same people who would now buy the stuff, if prices were low enough.

The big point here would not be the “exchange” window dressing, but making all information available. That seems exactly what banks fight hard to avoid, and a surprisingly large amount of people involved seem to agree that full transparency and the following panic could be a cure worse than the disease.

3 Kyle February 22, 2009 at 1:09 pm

I think this basically already exists. There’s no exchange, but there is a liquid index. For subprime there is the ABX market. For CDOs there was the TABX market. But, TABX stopped trading when everything plummeted to cents on the dollar. There isn’t, though, anything for ABS as far as I know (probably because it covers too many wildly different securities). But, the problem is not generating market prices for these securities, those exist, it’s just that the market prices are FAR different from where banks own them. Actually, the cash bonds trade worse than where the index would suggest.

That said, because the people who buy these assets now demand 10-20% loss-adjusted yields it’s not clear how valuable that information is on projecting future cashflows for banks. It’s certainly possible that some banks are both insolvent (assets outgoing cash flow from liabilities) since they only need to make a 5% return on their mortgages holdings.

4 Alex Turnbull February 23, 2009 at 12:06 am

A more pernicious problem is that these markets are OTC – some sort of public exchange or price reporting agency for Reg S securities and anything with an ISIN wouldn’t hurt. It certainly makes the 144A bond market pretty transparent thanks to the NASD and TRACE.

5 IWantCookieNow February 23, 2009 at 10:34 am

I wouldn’t mind to go further even: Put all these financial contracts things on a public stock or future exchange, including especially Credit Default Swaps.

6 Thomas Barker February 24, 2009 at 6:21 am

@babar – Clever! (And I think becoming popular with PE firms at the moment!) I suspect traders might notice that sort of thing happening though.

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