Wednesday, February 19, 2014

There is a saying on Wall Street that "Nobody rings a bell at the top or the bottom of the market". So when you hear someone talking about "ringing a bell" it means they think the market is too high or too low and will soon reverse itself. This occurred to me as I read an article about a bond issue backed by auto loans. This is a perfectly acceptable structure in the asset-backed bond world. The part that made me sit up and take notice is a recent issue of 500 million bonds. Because the demand for the bonds is so strong, the underwriters could raise 500 million from investors but had only managed to buy 400 million of loans because there are not enough car loans to go around the investors are buying a security with only 80% of the assets in the pool and a promise from the underwriters to buy the remaining 100 million as the loans become available. If this isn't the first act of "Mortgage Backed Securities Meltdown Part II", I will be very surprised. What got Wall Street over its skis in 2005-2007 was too much demand from investors for product and not enough mortgages to package and sell. Here we go again. As more of these deals are sold to generate underwriting fees the loans created to fill the demand will deteriorate in quality and the investors will eventually be holding worthless paper. There is a vision in my head of Quasimodo (played by Charles Laughton) jumping on a bell called Big Marie in the 1939 remake of the Hunchback of Notre Dame and ringing out a warning: Buyer Beware! of ABS (asset backed securities) backed by incomplete car loan portfolios.

On another note, as critical as I am about Congress they deserve some small measure of applause for passing the debt ceiling without all kinds of crazy conditions. The debate about the level of spending is one the country desperately needs but by tying it to a bill that funds the money already spent is the worst kind of political theater. Hopefully going forward we can have a real discussion about entitlements, defense spending, size of government, farm policy etc. Hope springs eternal.