In today’s Financial Times, Gillian Tett addresses the opaqueness of determining the “price” of collateralized debt obligations backed by mortgage loans and suggests an approach to gain some sense of the value of those asset-backed securities.
She points out that several banks have been sifting through the data on recovery rates after the CDOs had been liquidated. Tett notes:
The real shocker, though, is what has happened after those defaults. JPMorgan estimates that $102bn of CDOs has already been liquidated. The average recovery rate for super-senior tranches of debt – or the stuff that was supposed to be so ultra safe that it always carried a triple A tag – has been 32 per cent for the high grade CDOs. With mezzanine CDO’s, though, recovery rates on those AAA assets have been a mere 5 per cent.
An open auction, Tett offers, might bring some clarity to the pricing process and may attract investors:
But in a world where investors already feel utterly terrified by the inability to determine values – and the recovery rate on triple A assets has tumbled to just 5 per cent – conducting an open fire sale might now be the least bad of some terrible options.
After all, if an open auction ends up pricing mortgage-linked CDOs near zero, at least the capital hit to the banks and insurance companies will be clear; and if it is higher than zero, it might even cheer investors up.
Either way, until investors get some sense of what something might – or might not – be worth, it will be painfully hard to rebuild trust in capital markets and banks alike.