From a Bloomberg article about the second U.K. hedge fund this week to blow up due to subprime mortgage investments (via Jack Stevison):
"The losses are going to be phenomenal" for funds worldwide holding subprime debt, said Peter Schiff, president of securities brokerage Euro Pacific Capital in Darien, Connecticut. "My guesstimate in the subprime world is that the majority of loans are going to go into default. Not just 5 or 10 percent, but the majority."
I'd like to know if there are any funds making money off of these subprime woes. Can these CDOs or whatever the heck they are be shorted?
This reminds me of a speech Buffet made some years ago,
**
Before the Fed was established, the failure of weak banks would sometimes put sudden and unanticipated liquidity demands on previously strong banks, causing them to fail in turn. The Fed now insulates the strong from the troubles of the weak. But there is no central bank assigned to the job of preventing the dominoes toppling in insurance or derivatives. In these industries, firms that are fundamentally solid can become troubled simply because of the travails of other firms further down the chain.
Many people argue that derivatives reduce systemic problems, in that participants who can’t bear certain risks are able to transfer them to stronger hands. These people believe that derivatives act to stabilize the economy, facilitate trade, and eliminate bumps for individual participants. And, on a micro level, what they say is often true. Indeed, at Berkshire, I sometimes engage in large-scale derivatives transactions in order to facilitate certain investment strategies.
[Close associate] Charlie [Munger] and I believe, however, that the macro picture is dangerous and getting more so. Large amounts of risk, particularly credit risk, have become concentrated in the hands of relatively few derivatives dealers, who in addition trade extensively with one other. The troubles of one could quickly infect the others. On top of that, these dealers are owed huge amounts by non-dealer counterparties. Some of these counterparties, as I’ve mentioned, are linked in ways that could cause them to contemporaneously run into a problem because of a single event (such as the implosion of the telecom industry or the precipitous decline in the value of merchant power projects). Linkage, when it suddenly surfaces, can trigger serious systemic problems.
**
For folks who are wondering, `say, what the hell is a merchant power project?' and `how does that fit in with Warren's concerns?', I found the perfect link for you (and for me:d):
http://www.energy-tech.com/index.cfm?PageID=108&c2e=236&e2e=0&rs=0&artid=357
-Mike
You can short the ABX easily enough, the CDO market is a different animal. There's synthetic exposure, but no straight short positions. You can't deliver, buy in etc when you have no idea what it is you own/sold.
And the scary part is that its not just subprime. After the close AHM withdrew its full-year guidance:
"American Home shares have been hit hard by a jump in mortgage delinquencies, falling 40% so far this year. The company doesn't offer many subprime mortgages to poorer borrowers with blemished credit records, it has specialized in adjustable-rate mortgages and Alt-A loans, which often require less or no documentation of a home buyer's income."
http://www.marketwatch.com/news/story/american-home-mortgage-sees-second-quarter/story.aspx?guid=%7BF35E2A8C%2D80E3%2D4E9E%2D9A84%2D1B08486CE753%7D&siteid=yhoof
The money was already made by the loan's initiator and the seller of the CDOs. In the U.S., there is little recourse for the buyer. In the U.K. and E.U., more of the sales had clauses allowing recourse for the buyer if defaults rose past a certain level, which is why there were less of those CDOs there.
That said, aside from a few companies and funds, and spillover into the sector's stock prices, this is a non-event. Quote me on it, and see if the market doesn't recover quite nicely everywhere else (and in aggregate indices as well).
Take a look at this piece of news.
http://www.ft.com/cms/s/40f4f440-25ce-11dc-b338-000b5df10621,dwp_uuid=1c573392-3015-11da-ba9f-00000e2511c8,print=yes.html
It looks like there are derivatives that hedge funds can buy to profit from a drop in CDOs, but these derivaties are also structured and sold by the very parties who structured and sold the CDOs.
It is possible that a CDO and CDO derivative originator can manipulate news and prices such that most hedge funds lose whether they are long or short.
Can these CDOs or whatever the heck they are be shorted?
Not that I know of. Not directly. But take a look at, e.g., SRS (^DJUSRE) and SKF (^DJUSFN). In case you didn't already know.
Regarding SRS, I've been following it as a potential option for shorting the sector but it does not usually track well against companies' stocks. I think it's because it includes non-residential holdings which skews the performance.
Yes, SRS is not a way to short (almost) exclusively the residential sector. But many of the components of ^DJUSRE are REITs that have related/vulnerable investments. Which is why the index declined earlier this year when the subprime mess first got serious attention. So there may not be 100% correlation (or 200% given the leverage) between residential/subprime and used by SRS), but as goes XHB, subprime, etc so will go SRS.