Mortgage Mess: Is there Profit Somewhere?

November 10, 2008

A guest post from Frank Shump. Frank is a veteran from the financial services industry, and currently authors a blog called Thefinancecastle.com, which documents his thoughts on money matters and his adventures in self employment.

An often used saying when it comes to value investing is that you don’t want to “catch a falling knife.” Many times just when we think that stocks or commodities or any asset has been knocked down so far it can’t go any lower and buy in, it falls even further than we anticipated. The mortgage market is another area where experts and analysts think they’ve found a bottom, only to find out there really was no floor at all. Some funds, however, think they can make some money in this mess, and they know where to find it. With panic still ruling the markets and hedge funds eating huge losses left and right, one has to wonder where exactly they’re going to make their money in a sea of failure.

Look at Fortress Investment Group as an example. They had thought that bonds in the sector were attractively priced, and they made a huge bet trying to call the bottom. Unfortunately they ended up riding that bet down to yet another bottom, and their numbers show it. The fund had assets of about $940 million, and it’s down 47 percent in one portfolio, 42 percent in another, and 5 percent in a third. That’s as of the end of September, and things haven’t exactly improved since then. It’s possible that their bet may eventually pay off, but I’d be feeling pretty sick right now if I had a seat on that roller coaster.

Bryan Caisse, however, an 18-year veteran of the mortgage markets, thinks he can find some profit potential where so many have failed. He’s currently planning on launching Huxley Capital Management with backing from a United Arab Emirates investor. Supposedly, he claims that other hedge funds have been reckless in their use of leverage, and failed to properly handle liquidity challenges. As he put it, “Leverage is a very, very dangerous thing in any market; it can be deadly in a market where liquidity is uncertain.” No kidding?

To find these diamonds in the rough, Caisse says he’s looking for Fannie Mae and Freddie Mac mortgage bonds. These bonds are (surprise) trading at historically low levels even with U.S. Government backing. Through the use of “conservative leverage,” whatever that means, he sees some serious value opportunities, and hopefully profit down the line.

I’m sure I’m not the only one that’s skeptical here, but I can’t argue with the guy’s experience or success. Time will tell whether his into the line of fire strategy will work, but if other similar endeavors are any indication, the odds do not favor him.

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