Sunday, January 10, 2010

Valuing structured securities

Letter to the FT published in August:

A fraction of Tarp money is needed to enhance stability
Published: August 21 2009

From Mr Christopher T. Mahoney.
Sir, I think most capital market participants would agree that generic securities with liquid markets (stocks, corporate and government bonds) should be carried at fair value (“Disclose the fair value of complex securities”, August 18).
While the market price and intrinsic value may diverge, there is sufficient transparency for both the buyer and seller to have sufficient information to form an opinion, which is what makes markets.
However, structured securities are not generic and are generally opaque, especially complex derivatives such as collateralised debt obligations. No one can value a CDO-squared, which is why they don’t trade. Therefore, there is such a wide disparity between seller and buyer opinion of value that there is no meaningful market, and thus a very weak datapoint for valuation.
What should be incumbent upon all participants (but especially the financial regulators) is the creation of a public, robust structured-securities database and cash-flow based valuation methodology so as to provide an estimate of intrinsic value to be weighed against the noise in the mark-to-market valuation.
It is surprising that this need has been visible for over two years, enormous damage has been done, and yet there appears to be little progress in developing such a database. If a small fraction of the troubled asset relief programme had been spent on this, financial stability would have been considerably enhanced.
Christopher T. Mahoney,
New York, NY, US
Retired vice-chairman, Moody’s

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