In an article published in the New York Times, it looks like Wall Street is back at it.
In the drive for returns, they
are jumping right back into the risky investments which they had chased
previously. We know how that ended; crash and burn. Some Wall Street investors
made money as the mortgage market boomed; others profited when it fell apart. One Wall Street star thinks he knows better.
Having reaped big gains
during both of those turns, Greg Lippmann, a former star trader at Deutsche
Bank, is now catching the next upswing: buying the same securities built from
mortgages that he bet against before the financial crisis erupted.
Mr. Lippmann is joined by
other big-money investors — mutual funds like Fidelity as well as hedge funds in
riding a wave of interest in the same complex loan pools that nearly washed
away the financial system.
The attraction is the
price. Some mortgage bonds are so cheap that even in the worst forecasts, with
home prices falling as much as 10 percent and foreclosures rising, investors
say they can still make money.
“Given its significant
underperformance in 2011, we believe the product is as cheap to broader markets
as it has been in a long time,” Mr. Lippmann, whose portfolio is heavy with subprime
mortgage securities, wrote in a recent letter to investors.
I
n these uncertain times, how does an investor
really assess the integrity of the trader and the markets. One way is for investors to take a close look
at the market and make their own assessment of the market. Would you rather invest in Mr. Lippmann’s
optimism? Or in something much more real. Something you can relate to. Something that you can relate to- like real
estate.
More broadly, the nascent
recovery in the mortgage bond market supports a view that the housing slump may
have bottomed out. Sales of existing homes are picking up. State and federal
authorities have reached a $26 billion settlement with the big banks that is
expected to provide some mortgage relief. And the Federal Reserve Bank of New York
has been able to auction off billions of dollars of mortgage securities that it
acquired as part of the financial crisis bailouts.
“There is light at the end
of the tunnel,” said Kenneth J. Taubes, the head of United States investment
for Pioneer Investments, a global investment manager that owns these
securities. “The mortgage crisis is getting behind us, and things are getting
back to some semblance of normality.”
That optimism is an
about-face from 2006 and 2007, when Mr. Lippmann and others told investors that
housing was a bubble ready to burst. On Wall Street, Mr. Lippmann became known
as “Bubble Boy,” and one of his traders wore a joking T-shirt that read, “I
Shorted Your House.”
His exploits were
chronicled in Michael Lewis’s best seller “The Big Short,” which described him
as somewhat brash and crass. He was known for maintaining a sushi spreadsheet,
where he ranked the top Japanese restaurants in Manhattan on ambiance, quality
and cost.
These days, industry
competitors describe Mr. Lippmann, who runs LibreMax Capital, as a more mellow
presence. And he is much more positive about the market, telling investors that
his fund is reducing its hedge against a potential market crash. Through a
spokesman, Mr. Lippmann declined to comment.
Once again, they’re pulling out their crystal balls.
Haven’t we heard these predictions before?
As Larry Swedroe says in What Wall Street Doesn’t Want You To Know: “
The primary objective of most financial publications is not to make their
readers wealthy, but to get their readers to buy more of what they’re selling-
magazines.” The only way an investor can get around this is by being an
informed investor. Do your due diligence
and make sure that you ask the right questions. If you don’t know what those
questions should be, do your research.
Others in the industry are
also bullish, pouring money back into mortgage securities. Trading has surged
in recent weeks.
Prices have risen more than 15 percent in the first two months
of 2012, after dropping by as much as 40 percent last year.
“There was a lot of money
waiting on the sidelines because yields were starting to look very attractive,”
said Jasraj Vaidya, a strategist at Barclays Capital. “Lots of it seems to have
come out now.”
Yet the tide could turn
again and wipe out investors. Chief among the risks is Europe: the Continent’s
banks still hold a significant amount of United States mortgage securities, and
if they are forced to sell assets, it could wreak havoc on the market.
Washington is a question
mark, too. If banks have to pay for loans they issued under dubious
circumstances, it would be a home run for investors, who could receive full
payment for a mortgage in a security they bought at a discount. But if
borrowers whose houses are worth less than their mortgages are able to reduce
their principals on a large scale, bond investors could suffer because the
securities would be worth even less than they paid.
“As a money manager, you
can’t close your eyes to that potential outcome,” said Jeffrey Gundlach, a
founder of DoubleLine Capital, who has been buying mortgage securities since
2008. “To believe that this time we are really out of the woods and the prices
will not drop again is dangerous. People made that argument a year ago.”
Finally, some commonsense. We support an informed client. In fact, we
prefer that. We want our clients to
succeed and the more we can do to educate them, the better we can serve them.
The mortgage bond market is
a very different creature than it was before the financial crisis. For one, it
is much smaller: very few residential mortgage-backed securities have been
issued since the crisis. The market, at $1.3 trillion, is half the size it was
at its peak and shrinks by an estimated $10 billion every month.
Despite the limited supply,
prices remain cheap, in part because the assets are difficult to value. Hedge
funds and big investors use computer systems to analyze the underlying loans
and estimate, among other things, how many borrowers will default and how much
money can be recovered in a foreclosure.
Take one security, JPALT
2006-S1 1A11, which was built from Alt-A loans, or mortgages that required
little documentation verifying a borrower’s income.
On the surface, the numbers
are not encouraging: of the 799 mortgages underpinning the bond, many in
foreclosure-heavy California and Florida, about 21 percent are more than 60
days late on payments.
The annual default rate is
about 7 percent, and of the homes sold out of foreclosure, investors take a 54
percent hit, according to data from Bloomberg. On average, about 5 percent of
the homeowners refinanced their mortgages before they were due over the last 12
months.
That bond recently traded
at nearly 70 cents on the dollar.
At that price, even if
defaults and the losses increase, an investor can still make more than 5.4
percent, an analysis shows. In a rosier prediction, where defaults drop
slightly and the losses on the sale of foreclosed homes stay flat, the bond
returns nearly 8.7 percent.
“Price is a wonderful
thing,” said Chris Flanagan, an analyst with Bank of America Merrill Lynch.
“Yields in this market range anywhere from 4 or 5 percent up to 12 percent.”
With long-term interest
rates close to zero, such returns are hard to resist — even for investors who
were punished in the housing bust. The American International Group, whose
mortgage securities were acquired by the New York Fed in its more than $100
billion bailout in 2008, has been buying back some of those bonds. And a former
mortgage team from Lehman Brothers, which went bankrupt in 2008, formed One
William Street, a hedge fund that manages more than $3 billion in assets.
As for Mr. Lippmann, his
reputation has made it both easier and more difficult to get commitments from
investors. Some are impressed by his well-publicized bet against the mortgage
market; others are turned off by his high profile in an industry known for
secrecy and discretion.
LibreMax, made up of
several members of Mr. Lippmann’s team from Deutsche Bank, has raised more than
$1 billion in a little over a year. His performance has been relatively strong
during a period of market turmoil — up 2 percent last year and a little more
than 6 percent since launching.
Like his rivals, Mr.
Lippmann cites his experience in the housing market — including its boom and
bust — as a principal selling point for his fund.
“Because we have a trading
history, I think we understand very well how the street works, better than
perhaps people who didn’t work in trading before that haven’t had that
experience,” he said at a Bloomberg hedge fund conference in 2010.
As George Sauter of the Vanguard Group says, “even if
you identify the managers who have had good past performance, there’s no guarantee
that they’ll have good future performance.”
It’s important that investors pay attention to the market, take the time
to really understand what they are investing in and make sure the investment
aligns with their personal goals and objectives. Not every investment suits
every investor and you need to know what is right for you. Nobody can determine this for you. You are the person who has to take the time
to look at your circumstances, current and future, and determine what is right
for you.
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