Money managers under the microscope
Chicken Little was Quite the Optimist
By Martin de Sa’Pinto
If the sky falls, at least you know how far it can go – the worst case scenario is that it will hit the ground.
That’s not the case for the hedge funds, asset managers and banks exposed to toxic assets.
At the onset of the subprime crisis (identified in early 2007 although it began way before that), pundits who offered a worst case scenario of $200 billion in mortgage losses were accused of alarmism. That was in June 2007.
Those numbers only referred to defaulted loans. The effect of these defaults on securitized products such as collateralized debt obligations could only be guessed at, and at the time, few were guessing.
Worse still, the most highly rated tranches of these products were distributed to pension funds, insurers and municipalities around the globe.
By November 2007 Deutsche Bank analysts were estimating losses from subprime related assets (presumably including collateralized securities) could reach $300 to $400 billion worldwide, with banks and brokers writing down up to $130 billion.
Fast forward to January 2009. Subprime-related losses at banks and other institutions around the world have reached hundreds of billions of dollars, and total bailout funds proffered by governments around the world run into trillions.
And the write downs are not over yet.
In the meantime, defaults on the mortgages at the root of the problem have gone beyond the worst early estimates.
Even so, even if the value of all subprime mortgages together had gone to zero - meaning that the houses they went to pay for in the first place had no residual value after debts had been paid off – losses would not have gone far beyond $1-1.5 trillion.
Losses of that size would have been “ground level”, when the value of the underlying securities reached zero.
But kick in mortgage backed securities, collateralized debt obligations (CDOs), so-called CDOs-squared and credit default swaps, and losses could potentially – and with increasing probability – be far larger.
Which is why, where derivatives that turn bad are involved, it is possible for asset values to fall to the ground, and keep falling.