Thursday, 5 February 2009

Valuation uncertainty

A great data point from S&P via the New York Times:
The wild variations on the value of many bad bank assets can be seen by looking at one mortgage-backed bond recently analyzed by a division of Standard & Poor’s, the credit rating agency.

The financial institution that owns the bond calculates the value at 97 cents on the dollar, or a mere 3 percent loss. But S.& P. estimates it is worth 87 cents, based on the current loan-default rate, and could be worth 53 cents under a bleaker situation that contemplates a doubling of defaults. But even that might be optimistic, because the bond traded recently for just 38 cents on the dollar, reflecting the even gloomier outlook of investors.
Or as a friend of mine put it, `if you wanna throw the dart at the board and give me an HPI vector, I can tell you what the bond is worth. But who the hell knows what's the right HPI?' Given that future house price inflation cannot be known today, he has a point.

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