Tom Brown has a very interesting essay over at bankstocks.com, where he looks at 2006-vintage subprime mortgages and tries to come up with a cumulative loss rate for them. He makes the reasonable assumption that the ABX index represents subprime bonds more generally, and then looks at the ABX index on a bond-by-bond basis. It turns out that the numbers aren’t nearly as gruesome as you might think:
Of the $600 billion or so of subprime mortgages originated in 2006 (again, by the lights of what have gone on with ABX bonds), $282 billion have already been repaid, while realized losses have come to just . . . $12 billion.
Brown does a bit more mathematics and comes up with a cumulative loss rate of 12.8%, which is much lower than just about any of the estimates doing the rounds, and is also much lower than the loss rate priced into the ABX:
UBS, the only firm on the sell-side that’s analyzed the credit performance of the ABX bond by bond, uses loss estimate embedded in the price of the ABX itself and comes to an estimate of 18%.
Maybe now’s the time to start going long the ABX? The ABX-HE-AA 07-2 index, which I thought was a buy at 45, is now just 21. If Brown is right, it’s a screaming buy. But it has to be said that buying the ABX has been an astonishingly good way of losing money for the best part of a year now.