Mortgage Paper Will Crumple Balance Sheets

Looks like we have a collateralized debt obligation benchmark at last! Hallelujah. There's only one problem: It is one-sixth of face value.

There's a lot of horrid paper out there, paper that is made up of a mixture of a lot of mortgages of various styles and geographies and quality. It's floating around throughout the system, much of it "insured" so it got a status that is much better than it is worth, especially because the default rates in some of these mortgages are apparently running as high as 90% in some cases. Nobody knows what they are worth until now when Lone Star paid $6.7 billion for $30.6 billion of them (financed by Merrill Lynch (MER - commentary - Cramer's Take), so one-sixth could be an overstatement).

Lone Star owns Accredited Home Lending, which was formerly the 10th-largest subprime issuer, so it has some assumptions and some knowledge. It certainly wasn't pantsed. That means we now have a legit benchmark that could get this stuff off the sheets of all of these firms.

Of course, the big problem is that the valuation is ridiculously low, no doubt much lower than any firm is carrying them. Plus, the insurance that wrapped them has to be unwound, and the firms that took the insurance have to get paid something, and the underwriters have to stay in business even after paying, as Security Capital Assurance (SCA - commentary - Cramer's Take) will try to do. You can see how hard it is to unwind these complex instruments, let alone find a buyer.

My issue is who else has them, how are they valuing them, and are there other Lone Stars out there that want them, because we know that anyone else who has come near this stuff has presumably paid too much, or why would Fortress Investment Group (FIG - commentary - Cramer's Take) be down 30% already on the junk? (Funny that Fortress is managed by ex-Merrill fixed-income execs who obviously didn't know that their portfolio was now worth less than they thought after already being down 30%, but who knows where exactly they bought the gunk?)

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