Thursday, August 2, 2007

Transparency is Sometimes Scary

IndyMac (IMB) prides itself on providing transparency to its investors, a beacon in the complex and sometimes confusing financial services sector. (For a primer on the mortgage securities industry visit their webpage's investor relations section and read their investor presentations.)

Following this tradition and a disappointing earnings release yesterday (was anyone surprised?), their CEO went so far as to publicly release the e-mail he sent to his employees explaining the current situation:

Email from Mike Perry, Chairman and CEO: Conditions in the Private Secondary Markets and Their Implications for our Industry and Indymac

I would take a few seconds and read the e-mail if you are interested in trying to understand what is happening in the housing sector, but to quote an important piece:

"Unfortunately, the private secondary markets (excluding the GSEs and Ginnie Mae) continue to remain very panicked and illiquid. By way of example, it is currently difficult, at present, to trade even the AAA bond on any private MBS transaction. In addition, to give you an idea as to how unprecedented this market has become…I received a call from U.S. Senator Dodd this morning who seeking an understanding of “what is really going on and how can I and Congress help?”"

Basically the markets are frozen and no one knows what to do. I also heard from a confidential source that there are issues in the pricing of certain non-real estate related securities in the distressed debt market that people are struggling to figure out.

As major hedge funds hit hiccups, and the market reacts, it is not surprising that illiquid markets become unpredictable. The implications of this could be dire, especially for the real estate market as challenges in securitizations mean harder home mortgage refinancings.

Remember - look at the chart in the upper right hand side of this page - ARM resets are still rising and not at the peak. In other words, at the asset level, the worst is probably still yet to come.

Now, this may not necessarily translate into drops in all markets across the board, especially now that everyone is acknowledging the elephant that has been trouncing around the room. The key question is whether Greenspan is right in that the hedge funds and other sophisticates will find a way to arbitrage away the illiquidity or whether the irrational fear that is creeping into the markets will create an ever growing snowball.

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