In a lot of the articles I’ve read many people are saying it’s effectively impossible to do an accurate valuation on a lot of those tanking complex financial instruments which contributed heavily to pulling the market down. This is because not only are they loaded with imploding sub-prime mortgages, but these bad mortgages are not discrete entities that can be removed since they are comprised of bits and slices of other mortgage based securities, and you can never really get to the root value.
Although unstated I assume this is because it would be absurdly complex bordering on impossible to unwind, deconstruct and extract out the bad slices leaving on the ''good" mortgages for valuation purposes.
Well… difficult yes, but impossible? With enough brainpower and computer horsepower thrown at these securities wouldn’t it be possible to unwind them, remove (analytically) the bad elements, and get a decent handle on a rational market value?
That’s exactly what the big rescue package is designed to do. It has to be done to recover any of the money that’s being put in.
The difference between impossible and difficult manifests itself in the time it’s going to take to start untangling. That’s why the market is still gyrating. None of the information about what’s good and what’s bad will be available for weeks, if not months, and nobody’s going to be happy until it is. A lot of people won’t be happy then either, of course, but the uncertainly will diminish (it won’t go away entirely because some of it is impossible, so the wrong valuation will be put on some items) and that will help.
the ‘derivative’ part is diffiicult but not impossible to reverse engineer. At least on a probability basis.
the unknown is what is the underlying asset ‘worth’?
Say there is a collateralized debt obligation (CDO) based on 100 McMansions in Las Vegas. What is the $ value of the property. Just assume these homes went for an avg $1m each, that means the total these were sold for was $1b. Property in vegas has dropped 30% from the peak. 5 of these homes have been foreclosed and sold for $500k. 5 more are in the foreclosure process, if unemployment goes up and home prices continue to fall, more homes will foreclose. What is this billion dollars worth today? what about in 1 year, 2 years & 5 years? no one knows.
now try to price a CDO derivative based on the underlying. or try doing it on a complex derivative?