Monday, November 05, 2007

The Credit Crunch?

There was a popular game show many years ago where contestants could choose whats behind door 1, door 2,or door 3. Of course the doors weren't open and people could only hope that the prize was worthwhile and better than the trinkets that they were often giving up in exchange.

To a large degree the credit crunch is like that, banks and investors may be holding securities that resemble the prizes behind closed doors and are having great difficulty placing a value on the bonds which contain the mortgages. They cannot readily see what the makeup of the securities is. This is important because unlike on the game show the banks and investors are giving up a dollar in anticipation of getting that dollar back, plus interest,

If the underlying securities cannot be priced accurately then what do you do? They don't want to pay one dollar for something that is worth only 80 cents. Right now, banks are using pricing models that contained factors such as credit ratings and they have proved highly inaccurate and unreliable.

To be honest I am not sure that the billions of dollars being written off now will not be recaptured later on as capital gains as pricing transparency and accuracy become known.

That is just my two cents which might be marked down to just a penny in the near future!

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