but again, I think every body in or out of market heard things like this: "500bil option arm reset is coming within next couple months, and the whole CDS crap has not hit the fan yet." I think this is the typical fear of fear. Let me copy some analysis for third avenue's letter (Q1 2008, I changed some wording) ************** The publications pay little attention to the rules of seniority and priority of payment in evaluating, or understanding, senior tranches of debt. The argument that if an entity is in trouble, every liability on the balance sheet of that entity is also in trouble is strictly “amateur hour”. Frequently, senior issues sail through troubles unscathed. (Remember Third Avenue’s investments in Pacific Gas & Electric First Mortgages a few years back). A simple model of a Residential Mortgage Backed Security (“RMBS”) ought to suffice: RMBS – Original Balance Sheet ASSETS Sub Prime Loans Senior Tranches Junior Tranches $1,000 $600 $400 Assume 30% of the Sub Prime Loans default. Recoveries on defaulted loans are 50%. Performing Sub Prime Loans $700, defalut loan: $300, recover, $150, loss: $150. Since Junior tranches take loss first, it lost $150, so Loss for Junior Tranche is 37.5%, Senior tranches suffered no loss. ************** You can tweak the above number to see the loss for senior tranch under different assumptions of default rate and recover rate. Just remember one thing that CDO is debt backed by houses, and houses' value can't go to 0. Ask yourself this question: Despite the fear all over the market, what is the real default rate of subprime loans? Having some concrete number may build your confidence. As to 2000 tech bubble, this is really irrelevant. This is some historic data for financial, I found it from fool.com discussion board by Mungofitch without reference: "Financials, relative to the broad market, peak 1986 to trough 1990: -49%. Financials, relative to the broad market, peak 1997 to trough 2000: -47%. Financials, relative to the broad market, peak 2003 to today: -48%. This absolutely does not mean that today is the bottom. But, it’s fair to say that it’s of the same order as previous relative declines!" This is another article that provides a good perspective: http://www.bankstocks.com/ArticleViewer.aspx?ArticleID=5290&ArticleTypeID=2 I copied two graphs from the article below, you can see how stock price performed against how bad loan problem surfaced.
