Lehman Brothers Forced to Juggle Some of Its Own Hand Grenades; Where Are the Rest and When Will They Blow?
September 26th, 2007When the Wall Street Wizard couldn’t unload his mortgage backed securities anymore, he started to scrap bits and pieces his weirder paper generating machinery:
Finance America: Gone
BNC: Gone
Aurora Loan Services: Uh, what’s left of it will see a name change
Lehman Brothers bought these firms because they generated paper, and lots of it. Lehman repackaged and sold that paper to other institutions—like foreign banks—that were flush with cash.
And who wouldn’t want a piece of that big, fat, juicy U.S. real estate bubble? What could possibly go wrong…
As long as interest rates were low and there were buyers for the debt products that Lehman was peddling, the band played on. But as interests rates rose and terms like f@cked buyer and liar loan entered the discussion of the real estate bubble, one by one, Lehman closed down its paper mills and fired employees.
As we know, of course, the music stopped playing and Lehman got caught without a chair.
The fact that they have been forced to take several billion dollars worth of that dog shit paper onto their own books—as the supply of greater fools willing to buy it from them evaporated—seems like a semi-happy ending to this diabolical tale.
Not so fast.
The problem is that the $10.3 billion in paper that Lehman was forced eat represents just the tail end of the thing as the music stopped playing and their racket collapsed.
They have been generating and selling that stuff for years. Where did it wind up, and when is it going to blow?
I think that when might be easier to know than where:
Higher bars = more foreclosures = more liquidity problems months later
We are definitely not out of the woods with the subprime debacle. In fact, we are in for a year of steady increases in foreclosures and liquidity problems. There are no buyers for these securities now. If banks are holding these bombs, they’re stuck with them and the clock is ticking.
As those teaser rate loans reset, and f*cked buyers go bankrupt in increasing numbers (see chart above), banks are going to have serious problems.
Which banks will be affected?
I don’t know.
Oh yeah, Lehman has decided to stop hiding behind the names of the mom and pop shops it acquired to run this game. From here on out, it’s going to be Lehman Mortgage Capital.
Man, if that’s not a name you can trust, I don’t know what is.
Via: Wall Street Journal:
Lehman, a big player in the bond market hit hard by the recent trouble in the “subprime” business of issuing risky mortgages that has shaken the broader stock market, set the tone in terms of markdowns, taking a $700 million loss on assets that have fallen in value in recent months. At the same time, Chief Financial Officer Christopher O’Meara said “the worst of the credit correction is behind us.”
The $700 million in markdowns were cushioned, Mr. O’Meara said, by a combination of short, or bearish, positions on certain securities and a variety of hedges Lehman used to protect itself. More broadly, he added, the firm’s diverse business mix shielded it from more significant losses during the quarter.
Still, Mr. O’Meara said the difficulty of selling loan commitments to third parties and the lack of buyers for securitized mortgages caused Lehman to take $10.3 billion in assets onto its balance sheet, a move it wouldn’t likely have make under calmer market conditions.
Of that total, $4 billion is deal financing, and most of the remaining $6.3 billion is newly originated home loans that haven’t been sold off as part of securitized products, he said. Bringing such loans and securities onto its books could subject Lehman to losses if markets continue to erode. The move also ties up a portion of the firm’s balance sheet it might have wanted to deploy elsewhere.
One data point investors focused on yesterday was the percentage markdown Lehman appeared to be taking on its leveraged loan commitments as it tried to sell off deal financing to third parties at depressed prices.
Research Credit for ARM Reset Crart: Idleworm, Calculated Risk
One thing I’ve been thinking about since reading the Hayman PDF:
In regards to buyers being stuck holding these worthless CDOs that they can’t sell, it’s obvious that they’re not only going to be upset – they’re going to be pissed. My question is, just how pissed do you think some of them will be? What I mean is, how far do you think will they go – or what alternative collection methods will they use – to recoup in some way or another? Obviously some of these buyers would be, uh, well connected, I imagine…
Oooo, February, March, and April are going to be teh ugleee!
il, my thinking is that the buyers of this worthless paper have no recourse other than to file suit against whatever financial entity it was that sold it to them–and maybe the rating agencies that rated them AAA. (Lots of luck! Bear-Stearns is incorporatted in the Cayman Islands.) The investors are in no position to foreclose, or otherwise go after the defaulting individuals.
I think we’ll see a lot of lawsuits, and still more demands for bailouts. Northern Rock paid its investors a freakin’ dividend–and its CEO is still being wildly overcompensated, in the midst of this debacle!
To the extent that these institutions are bailed out, the rest of us will be screwed. To the extent they don’t the investors will be screwed–which includes a lot of pension funds and, I think, municipal governments.
Most of these people have been screwed before, so they are used to it. Thousands of people have been screwed out of the pensions over the past decade or so, by companies that just decided to abscond with the money–with the blessing of the government. No torches and pitchforks have yet been in evidence.
I’m guessing here, but I would say that there are very specific rules that kick in when the borrowers get behind on their payments.
I would guess that you have the originating lender (“chop shop”), and the current owner of the debt obligation and then a separate administrator of these loans. The buyer of the MBS or CDO probably has to pay a pre-decided admin fee to the administrator.
So when the McMansion buyer (NOT owner) can’t pay the required amounts in repayments anymore, they would get x number of warning letters from the administrator, then some letters from the lawyers, and then after a certain time has lapsed without satisfactory loan rescheduling, it’s kapow–foreclosure, eviction and mortgagee sale. I’d say that the only leeway in this process is if the buyer tries to stall by negotiating new terms. But I suspect these exotic loans have very little room for manoeuvre. The knife probably falls pretty quickly and there are probably very few chances for escape.
So when all these ARMs reset next spring/summer, it’s just a matter of time before the foreclosures start snowballing big time.
Grab that pop corn. This could be a long show.