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No Bad Bonds, Only Bad Prices


And prices reflect widespread, government-fostered uncertainty.

While politicians continue to talk about the need to keep people in their homes, maybe we should examine the results of loan-modification efforts thus far.

Government agencies are reporting that almost half the loans modified in the first 2 quarters of last year are delinquent again after 8 months, and that third-quarter trends "are worsening." The ability for bankruptcy courts to change the principle value of loans will probably not fair much better, and in the process, might destroy the private-label MBS market.

It seems to me that there's very little that can be done within reason to keep someone in a house they can't afford (and may not even want anymore). Letting markets determine the fair value of assets might not be pleasant or politically correct, but it's a necessary step to any long-term recovery.

Yesterday, over a billion dollars in prime, Alt-A and subprime mortgage-backed bonds were sold as part of the Thornburg liquidation. As Professor Andrew Jeffery discussed in Jumbo Prime R.I.P.:

"Thornburg's stock was delisted last December as a series of last-ditch efforts by CEO Larry Goldstone failed to save the company. With investors buying nothing by government-backed Fannie Mae (FNM) and Freddie Mac (FRE) mortgages, Thornburg's bread and butter -- jumbo loans -- became virtually worthless."

And yet, I'm told over 80 market participants bid on the bonds, and the list traded at the upper end of expectations, albeit at very low absolute levels. Reasonable people can disagree, but I don't think it's accurate to call these levels "distressed" when 80 professional money managers are competitively bidding against one another.

To me, that's the market. As I've pointed out before, there are plenty of people willing to buy this paper; not surprisingly, they just want to buy it at the right price. Remember: There are no bad bonds, only bad prices. And the prices today have to reflect huge amounts of uncertainty. Ironically, it's the government that's creating a lot of the uncertainty by continually changing the rules.

That's why most market participants are lukewarm about participating in TALF and PPIP: The government is the worst kind of business partner - one that can't be trusted. (Bridgewater, the hedge-fund giant, seems to have realized this, albeit belatedly; it's withdrawn from participating in PPIP.)

I think we need to let the markets work, and the only thing most of these government programs do is push the pain further into the future and waste a lot of money.

As Minyan Peter says, problems in economies like ours don't get better with age.
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