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AAA-Pricing

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May 02, 2008 – Comments (0)

This FT article has some arguments that suggest current pricing on AAA-rated out of whack, and low.

"And as bankers stagger about trying to make sense of these swings, it seems that the Bank of England has now joined this “dazed and confused” club too. In its latest financial stability report, the Bank suggests that the price of some AAA securities only makes sense if you believe that the ultimate loss ratio on securitised subprime mortages will be 38 per cent. However, that loss can only occur if three out of four households defaulted on their loans and house prices tumble dramatically too. "

Haven't home prices tumbled dramatically?

It will be interesting to see how much of the subprime actually ends up in default, but there is also the Alt-A and what happens to prime when equity is wiped out?  Prime mortgages in some areas in the past couple years no longer have any equity and some are negative equity now. 

But say you expect real rates to be say 1% higher over 30 years, so these things pay 5% and you need 6%.   So, 1.05^30=4.32, and 1.06^30=5.74.  I think this means these things would be worth 75c on the dollar if there were no defaults.

 

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