Pricing exceptions are widespread in mortgage — and so are the regulatory risks

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Subprime Bond Market ‘House of Cards’ Set to Fall

Update: A reader contacted me regarding the Highland Fund discussed in the NY Post story cited below. The Post had incorrectly printed that the Fund had been shut down, which I of course cited. The NY Post has since published a correction, and so I’ve edited the below post to correct for their error. Two new stories from Roddy Boyd at the New York Post hint that the game may be up in the CDO market, the last refuge of the “toxic waste” from the subprime lending boom. I published a highly-read post here at HW on CDO subprime exposure way back in February, and it now looks as if the equity tranches that had everyone worried back then are finally coming home to roost. The first story highlights mark-to-market problems, sort of the primary crack in the bond market’s foundation:

Already, Highland Financial Holdings Group’s $125 million Special Opportunities Fund…dropped over 20 percent [according to sources cited in the story]. Highland managed a total of about $900 million, and was awarded a risk management award in 2004 from Risk Magazine.

Boyd also calls attention to Carrington Capital Management, who last month paid $188 million for the loan-servicing operations of now-defunct subprime lender New Century Financial:

Carrington has raised eyebrows among rivals with its portfolio-valuation methods. In a year when subprime mortgages have taken sharp losses, Carrington was up 0.86 percent through April. The fund values its bonds based on the amount of principal and interest payments the bond is anticipated to make, while most funds use current trading levels.

The second story gets to the timing of where the market is headed, and doesn’t paint a pretty picture. In particular, looking at the Bear Stearns soap opera:

The bond market’s most battered players – the hedge funds and trading desks specializing in mortgage-backed securities – now have to handle a total of $2 billion or more hitting a market that is still licking its wounds from the first burst of sub-prime woes. The sales are likely to force a serious re-pricing of billions of dollars worth of highly complex and often illiquid securities called collateralized debt obligations… “They haven’t collapsed in price because they are often mismarked or just don’t get traded,” said one hedge fund executive who has evaluated the Bear fund’s positions. “That is going to change in a big way today at 4 p.m., when the [Merrill] auction ends.”

Even more ominous:

Lehman Brothers and Credit Suisse voted with their feet ahead of Merrill and auctioned off smaller amounts of Bear’s portfolio yesterday afternoon, with Lehman taking 50 cents on the dollar for some bonds. Merrill’s traders, according to several hedge fund managers, would gladly take that much. [Emphasis added]

50 cents on the dollar? Looks like round two of the subprime crunch is already here. Update: I keep watching the rating agencies — Fitch, Moody’s, S&P — for some sort of CDO ratings action. Or at the very least, some sort of analysis or notification that some CDOs are being placed under review. But, so far, nothing. Nada. Zip. Zilch. Zero. C’mon, boys — do you really want to be late to the party? Again? The subprime bond crisis caught you flat footed, and now you’re looking slow to move on CDOs as well. Maybe this talk of CDOs blowing up is overrated — then say so. But at least say something. Anything.

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