So today the big capital is not on the investment banking desks, it's sitting in hedge funds. They have their own kind of credit officer/manager, except he works for their prime broker, which is housed in an investment bank.  Those investment banks have been lending 95-98 cents on the dollar against AAA and AA rated mortgage loan pools. According to one friend at a hedge fund, AAA pools are trading at 90 cents and AA pools at 79 cents on the dollar.  Those pools, if properly hedged against interest rate risk, were not meant to move more than a few cents, according to most theoretical models.  So you have a difference between theory and market liquidity.  And it's liquidity that the prime brokers need to get their money back, theory doesn't help much.  

I remember watching as smart Prime Brokerage departments at places like Morgan Stanley started to liquidate and demand more collateral from their clients - even their best clients.  Hedge fund clients screamed, threatened to move business elsewhere or sue, but at the end of the day the prime broker has the power. The smart ones want to keep their money, so they demanded liquidation.  

Where does this leave me?  I think things will get worse before they get better.  If we get that sigh of relief before we see a bunch of liquidations, that will be your opportunity to sell.  If there is no sigh and just liquidations, that will be the time to buy, but don't buy with your most leveraged capital because you don't know how long these things take to work out.

So what am I doing? I'm analyzing banks, brokers and mortgage funds for health.  I want to have my buy list ready when the time comes. I know I won't have time to analyze at that point.

Disclosure:  I own several banks, brokers and mortgage funds now.  However, I may buy more. 

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