Is Wall Street just remixing soured mortgage securities for profit?
Oct 1st 2009 11:00AM
Updated Dec 4th 2009 4:15PM
Wall Street firms have found a new way to make money on their badly packaged real-estate mortgages: "re-remics" -- short for "resecuritization of real estate mortgage investment conduits." Sounds to me more like revaluing bad investments to make a firm's bottom line look better and possibly sell off toxic assets at a higher price.
Basically, re-remics unwind the complicated CDOs that were mixed with prime and subprime mortgages to get higher ratings for the mortgages that are still performing well. By doing this, the bank or financial institution can then show it holds higher-rated securities that require less capital, thus freeing up cash for other financial activities.
Regulators worry that this new gimmick will just be a way for Wall Street firms and credit agencies to make more money with new fees -- and leave us with another financial crisis if the newly unwound securities don't actually perform better. Regulators don't trust the credit ratings firms to fix the mess they created with the ratings of these soured assets before the financial crisis.
Instead the American Council of Life Insurers thinks these remixes should be handled by analytical firms with expertise in residential mortgage-backed securities. This would help regulators determine the value of deteriorated holdings in insurers' portfolios. The council wants to bypass credit rating agencies completely. Instead, the experts would help analyze the true value of insurance company holdings, size up potential losses, and determine how much capital insurers need to hold.
The key is the credit rating of the security. Institutions must hold a certain amount of capital based on the rating of each security on their books. The Wall Street Journal discussed an example from Barclays Capital (BCS) that showed a $100 million asset requires $2 million in capital if rated AAA, but may require $35 million in capital if downgraded to BB. At CCC the capital required could be 100 percent or $100 million.
Right now, so many of the mortgage-back securities have been downgraded that financial institutions must hold a large percentage of these mortgage assets in capital, freezing up their portfolios. Yet since large segments of these securities are still performing well (mortgages are still being paid, for example, on the prime mortgages in the mix), the firms want to find a way to unwind the good from the bad. That way the assets performing well can again be rated AAA, AA, A or BB, and less capital will need to be held.
In a June report Barclays estimated that there is $350 billion to $400 billion in securities with no natural buyer due to their ratings. By unwinding these securities with no market, Barclays believes that a lot of cash can be freed up for those assets performing well.
Wall Street firms getting into the re-remic action include JP Morgan Chase (JPM), Credit Suisse (CS), Jeffries & Co., Royal Bank of Scotland Group (RBS), in addition to Barclays. Citigroup (C) is pursing its own re-remic strategy to repackage its toxic assets. Insurance executives looking to repackage toxic assets in their portfolios are paying 0.35 percent to the investment banking, credit ratings firms, as well as legal and other costs.
The National Association of Insurance Commissioners, which includes state insurance regulators, agrees that toxic assets needs to be repackaged, but wants it done without the credit ratings agencies and at a lower cost. They plan to discuss re-remic accounting treatment at the December meeting of NAIC regulators.
Clearly the investment bankers and credit rating agencies that got us into this mess should not be the ones who are paid to find a way out. Hopefully, the NAIC regulators will find a system that is less costly and more beneficial to those stuck with these toxic assets.
Lita Epstein has written more than 25 books including Reading Financial Reports for Dummies and Trading for Dummies.