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Five Things You Need to Know: Three Words: Mark to Market; How Could This Happen?; Leading Indicators Successfully Marked to Market; Florida Fears Real Estate Boom May Have Ended; Finally Some Good News!


What you need to know (and what it means)!


Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Three Words: Mark to Market

Read them. Learn them. Know them.

  • With the collapse of the very excellently-named Bear Stearns High Grade Structured Credit Strategies Enhanced Leveraged Fund, there are now three words folks are being asked to learn this week: Mark to Market.
  • What is this, how you say, Marky Mark?
  • First, we said Mark to Market, not Marky Mark.
  • Mark to Market is the act of assigning a value to a position based on the current market price for that instrument.
  • That sounds simple enough. Why is that an issue for Bear Stearns' funds?
  • Because the funds were heavily invested in Collateralized Debt Obligations (CDO's).
  • CDO's are so illiquid - meaning they trade so infrequently - there is no market to mark them to.
  • OK, then how are they valued?
  • With models that the major credit agencies use based on past and current default rates and cash flow.
  • Wait a minute, if the models are based on past and current defaults, what happens if there is a sudden surge in defaults... like we are experiencing right now?
  • Nothing.
  • And doesn't this raise conflict of interest questions between the credit agencies and their customers?
  • Yes.
  • In fact, this is an issue Minyanville Professor John Succo wrote about more than a month ago and again today.
  • The bottom line is that even though the mortgage market has deteriorated substantially, mark-to-market losses by those holding the CDO paper have generally not been realized because accounting rules only require holders of the paper to mark prices according to the accepted model, not actual prices.
  • That is about to change.
  • Below is a chart of the BBB minus tranche of the mortgage-backed securities pool from November '06 to present, courtesy

    Marky Mark and the Funky Tranche?

2. How Could This Happen?

"Traders and industry executives who saw lists of C.D.O.'s on offer from the Bear Stearns funds say that even as the manager of the funds, Ralph Cioffi, bought some protection against a deteriorating housing market, on balance his investments seem to be based on a belief that the subprime market would not crumble, or at least not soon," the New York Times reported this morning.

  • Now, that raises the following question: How would a smart hedge fund manager arrive at the belief that the subprime market would not crumble?
  • Probably by listening to the following experts:
    - March 28, 2007: Federal Reserve Chairman Ben Bernanke said, "At this juncture ... the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained."
    - March 29, 2007: Treasury Secretary Henry Paulson said he thinks the economic damage from the subprime lending crisis is "contained."
    - April 4, 2007: Federal Reserve Bank of Dallas President Richard Fisher said damage from the U.S. subprime mortgage market is "mostly contained."
    - April 11, 2007: The subprime mortgage market is "little more than an asterisk in the overall U.S. credit economy," said Roth Capital Partners economist Donald Straszheim.
    - June 12, 2007: Lehman Brothers Chief Financial Officer Chris O'Meara said Tuesday he remains confident that weakness in the nation's subprime mortgages is waning.

3. Leading Indicators Successfully Marked to Market

The Conference Board's index of leading economic indicators increased 0.3% in May, above the consensus expectations for an increase of 0.2%, after being successfully marked to market.

  • The Conference Board's index of leading economic indicators increased 0.3% after a 0.3% drop in April.
  • So we're basically back to even.
  • Five of the 10 indicators in the report had a positive effect on the index, five no impact or were negative.
  • So again, we're basically back to even.
  • The positive contributors were average weekly initial claims for unemployment insurance, stock prices, building permits, index of consumer expectations, and vendor performance.

4. Florida Fears Real Estate Boom May Have Ended

In the clearest sign yet that [Florida's] real estate boom has ended, Miami-based Ocean Bank confirmed Wednesday that it has filed a $50 million foreclosure action against the developers of a Boca Raton condo conversion, the Palm Beach Post reported.

  • Ocean Bank said NRW Development LLC, a South Florida real estate development firm, and six individuals owe $50 million on a condo conversion known as Villa Mare Beach & Yacht Club Residences.
  • The Ocean Bank lawsuit says NRW and six other borrowers stopped paying on the loan in December, only seven months after NRW borrowed $60 million to pay $57 million for the property, the newspaper reported.
  • Say again? Only seven months after what?
  • Only seven months after NRW borrowed $60 million to pay $57 million for the property.
  • Ocean Bank has a loan portfolio of $4.5 billion, the article said, with past-due loans now edging upward past the $208 million mark.

5. Finally Some Good News!

Finally, some real estate good news! The Federal Deposit Insurance Corp., the agency that insures deposits at U.S. banks, says it overstated the severity of past-due residential mortgages last month because of calculation mistakes.

  • Whew, finally! Finally some good real estate news.
  • So what did they do? Miss a couple of decimal points? Count some past-due loans twice? Round up instead of down?
  • Hmmm, not exactly.
  • The agency said it accurately reported that 1.13% of residential loans are past due through the first quarter of this year.
  • So what's the mistake? What's the good news?
  • Well, it turns out that overdue residential mortgage loans, instead of reaching a 17-year high during the first quarter, only reached a 13-year high.
  • So overdue mortgage loans are only as bad as 1994, not 1990.
No positions in stocks mentioned.

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