Wednesday, February 20, 2008
the disaster that wasn't in level 3?
i myself worried at length over the growth of level 3 assets, paticularly noting that many CDOs were held as such, and mentioning FAS 157. fears of CDO losses are material, of course -- many CDOs are in fact worth far less than was once supposed. and it would be an obvious mistake to interpret prof. miller's comments as a total exoneration of CDOs.
however, he chides alan abelson a bit for this. abelson's mention of level 3 is, on further inspection, pretty sensible:
More specifically, Janjuah predicts that U.S. banks and securities firms are looking at perhaps $100 billion of write-downs on so-called Level 3 assets, as the new Financial Accounting Standards Board rule 157, slated to go into effect this week, takes it inevitable toll.
... According to Janjuah's calculations, Morgan Stanley, which is still grimacing over a recently disclosed trading loss of $3.7 billion, has 251% of its equity in Level 3 assets. At Goldman Sachs, the Level 3 commitments run 185% of equity. At Lehman, such assets are the equivalent of 159% of equity; at Bear Stearns, 154%.
Citigroup, which owns up to something like an $11 billion hit from subprime and other bum loans, a dismal total that occasioned the exit of its top man, has Level 3 assets equal to 105% of its equity. Rather ironically, Merrill Lynch, which is upward of $8 billion poorer after taking its bitter medicine to purge itself of overvalued subprime and assorted other loans, and whose CEO also was shown the door, has Level 3 loans equal to 38% of its equity. That makes it the least vulnerable of the major lenders.
We're not suggesting, need we say, that every Level 3 security on a bank's books is at risk or will have to be written down. But in total, they represent one massive pile of uncertainty, of which the lenders and the credit markets already have more than a surfeit, thank you.
if i recall correctly, banks have in fact taken writedowns amounting to $115bn so far, a number that is still growing weekly. i've come to consider that mr. miller, insightful as he is, sometimes exhibits a tendency (as do we all) to attack a strawman -- and this might be one such case. some people were literal where abelson's headline came across as a bit of cheek, and if those are the target of prof. miller's sarcasm then well so. however, that's not abelson.
however, he is exactly right to say:
No one wants to think about FAS 157. It is over the barrier of complexity. If things get too technical, everyone tunes out, no matter how important the topic. ... This myopia is empowering for those who take each issue to the lowest common denominator. FAS 157 was a big story when the bearish bloggers saw last November 15th as a doomsday date like Y2K. When it did not happen, the powerful writers in mainstream media did not point this out. There is no accountability.
i think it's too much to say that those who were concerned about the growth of level 3 pricing were barking up a phantom tree -- subjective abuse of mark-to-model pricing exists, as it always has, and we have in fact seen steep writedowns emerge from CDOs as auditors force compliance. yves smith relates an article from ft's john dizard which in fact expressly fingers FAS 157 as the vehicle of the logic and social dynamic of efficient market pricing -- and which is aggravating a downward spiral in the credit markets that is "discounting the end of the world".
but it is also important to note that there are more optimistic voices in the financial world with respect to the ultimate losses. prof. miller cites tom brown, tiger cub and manager of failed financial services fund second curve capital. (mr. brown also weighs in on the bull side of the monolines.)