It is well known that prices of securities backed by risky mortgages are difficult to calculate. And as long as no securities are marked to market, we can all happily live with the notion that ”it probably isn’t that bad”.
One way of at least estimating the current market value of these securities has been to refer to the ABX index (a mortgage backed credit derivative index). According to that index, AA-rated subprime backed bonds trade at about 45 cents on the dollar. Do you realize the size of losses hidden behind these numbers! (Goldman Saches estimates that discounts in the ABX market suggest total subprime losses of about $400 billions.) Well, the optimists say, that is just an index. Maybe demand and supply effects have made it overshoot?
The bad news for the optimists suggesting that speculation and illiquidity is behind these numbers is the fact that this week we saw one of the first true purchases of debt backed by subprime mortgages. Citadel Investment Group bought a couple of billion of such debt from E*Trade for 27 cents on the dollar! Not all that debt seems to be backed by subprimes, but still. If that is the setting of a new standard, investment banks should tremble…
Am I the only one who finds these values striking! I do not think this debt is cheap, I just look with awe at the dramatic write downs in the value of (supposedly) safe debt investments! And at the gigantic future write downs we can expect from the big banks..... I hope I am wrong!