Thoughts on subprime stuff

Many people question why it is that banks on the verge of failure can't sell their subprime mortgage paper themselves, and why Treasury has to be the buyer of last resort. Are mark-to-market prices really absurdly low? If they are, where are the private speculators, the vulture funds? Why aren't they greedily buying this cheap paper?

One reason that is not widely understood is the extreme complexity of subprime mortgages. Where I used to work we had a small army of people who did nothing but track (almost daily) the cash flows of different mortgage securities, under the direction of a guy who has spent his entire professional life studying mortgages. These were smart guys, but they were blindsided just like everyone else. Things happened that were unforseeable at the time, to securities thought to be virtually bullet-proof.

An outsider would find it extremely difficult to step in and buy distressed subprime paper from a desperate bank. Evaluating these securities is extraordinarily difficult, complex, and time consuming. Every tranche of every deal (numbering in the hundreds and thousands) is unique. These are not your typical junk bond. What are they really worth? Who knows?

The value of a subprime mortgage-backed bond is a function of multiple independent variables: the level of interest rates, the shape of the yield curve, prepayment speeds, housing prices, the structure of each individual security, geographical exposure, and volatility assumptions. A handful of experts can attempt to make sense out of all this, but for the vast majority of investment professionals, it is virtually impossible.