6/9/2008: ABX overstates subprime losses, says BIS

Excerpts from BIS Quarterly Review, June 2008

Estimating valuation losses on subprime MBS with the ABX HE index — some potential pitfalls

Repeated large-scale writedowns of exposures to the US mortgage market and continuing deterioration of the US housing sector have given rise to strong public and private sector interest in estimates of overall subprime-related losses. In this context, particular attention has been devoted to estimated market value changes for subprime mortgage-backed securities (MBS) and how these compare to disclosed writedowns by banks and other investors. A key source of data for such estimates has been the ABX HE series of indices based on credit default swaps (CDS) with subprime exposure. This box conducts a simple analysis of valuation losses on subprime MBS on the basis of ABX prices and highlights a number of possible limitations of such estimates. In particular, it is argued that past estimates of total valuation losses at the AAA level may have been inflated by more than 60%. ... [U]sing newly available data for MBS tranches with shorter durations, the $119 billion of losses implied by the ABX AAA indices as of end-May would be some 62% larger than those implied under more realistic assumptions.