05 April 2009

Yes We Can - Value Mortgage-Backed Securities

I can't tell what exactly the FASB (Federal Accounting Standards Board) did about "Mark to Market" valuation. (Earlier I wrote about how Mark to Market is destabilizing, making up markets go up too fast, and down markets go down to far.) Not even the Wall Street Journal seems to be able to report in any detail on what they've done. But it seems that firms can now mark assets to what some sort of extrapolated market would do, if the market were functioning "normally."

Bullshit. That's make-believe. If the actual market is non-existent, just make one up. There is no justification for this nonsense, because there is a real way to value assets, which I've also written about earlier. It's called expected discounted cash flow.

Let's pick what the Wall Streeters claim is the hardest of all assets to value right now - mortgage backed securities. For each one of them, an electronic and/or written trail exists to track down each mortgage and mortgagee that is bundled into each one of those securities. It is therefore possible to track down each mortgagee and do the due diligence (check his/her credit history, income, employment stability, loan amount, monthly payment, payment history, historical and present market value of the property that is mortgaged, etc.) and make a probabilistic determination of his/her likelihood of continuing to pay that mortgage. That probability times the number of payments, times the value of the payments discounted for inflation (again estimated from the historical moving average of the Consumer Price Index over any n-year period, where n is the number of years left on the loan) is the expected discounted cash flow from that mortgage - that mortgage's value.

Now if a non-accountant like me can figure out how to value mortgage-backed securities, you can be sure that the Wall Street accountants know how to do it. So why don't they do it? Because they already have a pretty good estimate of the answer and they don't like it. They don't want to know. And more importantly, they don't want you and me to know.

In other words, they're lying. They're still trying to keep from having to come clean and do business the right way.

It is not conceptually hard to value mortgage-backed securities. It is conceptually easy. The only hard thing about it is that it is tedious. A lot of people are going to have to hit the streets and do a lot of due diligence that was not done when these things were bundled up and sold and bought in a vast game of financial musical chairs.

Well, get to work all you lying assholes in the financial industries. I'm a taxpayer, and I want my chair back.


motheramelia said...

Well written and astute. I'm sure the reasons are as you state. Not wanting to know the answer and not wanting others to know seems to be prevalent in many areas, not just finance. Just look at the clergy abuse stuff.

Anonymous said...

Conceptually it is incredibly simple. Practically, your proposal is pretty much impossible.

Coming up with the probability of someone continuing to pay their mortgage is just as much playing make believe as guessing the value of an MBS in "normal market conditions". It's not just defaults on dubious loans causing the problem anymore. People with respectable payment records working at what were once considered blue chip companies are losing their jobs and becoming unable to make their payments.

The past is a questionable indicator of the future at best, especially in times like these.