Comments on Rick Bookstaber: Mark to value versus mark to liquidity during mark...

Rick, first I would like to say that I thought tha...

2008-01-06T10:09:00.000-05:00

Rick, first I would like to say that I thought that your book A Demon... was one of the greatest investing books I have ever read. I learned a lot. I wonder if you could do a piece on CDS and explain how a buyer or a seller of CDS actually gets paid. Do they sell them in an opaque market? Do they have to wait for a default? Do they really need to supply the actual instrument that the CDS is related to in order to get paid off? Etc. I would really like some clarity as what these instruments are and what they are not. Thanks. Dr. Steve

Rick,
Thanks for the post in response to my com...

2007-12-07T13:27:00.000-05:00

Rick,
Thanks for the post in response to my comment on the prior post.

Alex, I think there is evidence in the E*Trade deal that the ABS transaction stands on its own. Blackrock was a participant (for $100MM) in the senior notes + stock capital infusion, but not in the ABS transaction - only Citadel participated in the ABS transaction. It is not clear what other source of value there is in the deal for Blackrock aside from the straight purchase of those securities. Beyond that, we don't know what the mix of the RMBS securities was between AA and AAA. There could be an enormous difference in value between a super senior AAA and the AA tranches, that may help explain the $800MM price.

The reverse side, however, is that mark to liquidi...

2007-12-07T11:36:00.000-05:00

The reverse side, however, is that mark to liquidity would create its own problems when there is a crunch; you would have the same kinds of fire sales for different reasons, or in even more ugly cases, blow ups.

Like any other problem worth contemplating, there is obviously not an easy answer here. Too much mark-to-make-believe-values causes blow ups in the same way that mark-to-liquidity would cause the same.

Though, ultimately, anyone seems less likely to get pinched if they are not highly leveraged...

Hmmm.

Mark-to-Liquidity in this market is m...

2007-12-06T21:27:00.000-05:00

Hmmm.

Mark-to-Liquidity in this market is mark-to-market and is at least somewhat objective. Mark-to-Value is subjective. Value according to whom? If I have the conviction of a value I should be prepared to own it at the depressed liquidity price because I have faith it will one day be priced at value. The logical extension of what you are advocating is that if I buy an at-the-money call, but believe the price of the underlying will double (for reasons I believe are sound) I should be able to price that call on my balance sheet at the value I perceive. A good way to print money, but it seems to encourage the type of mess we are in. Though the government seems to be in your camp with the Paulson sponsored mortgage mismarking scam.

I think that the 800mm price that's quoted for E-t...

2007-12-06T11:39:00.000-05:00

I think that the 800mm price that's quoted for E-trade's ABS is potentially misleading. Remember, the ABS sale was only part of a more complicated transaction: Citadel paid ~$2.5b to get a basket comprised of E-trade's hard-to-mark ABS portfolio, a 12.5% coupon on hard-to-mark E-trade debt, and a big slug of easy-to-mark E-trade common stock. One can't say that the ABS portfolio traded at 800mm because the trade didn't occur in isolation. And there's a lot of uncertainty as to the yield at which E-trade could have issued a big slug of new debt. It may have been advantageous to either Citadel or E-trade (for tax or other reasons) to ascribe a low price of 800mm to the ABS piece of the transaction and a higher price (lower yield) to the debt part of the deal.