The worst part of the current credit crisis is the uncertainty: No one wants to buy up risky mortgage debt instruments, so no one knows how much the toxic debt is worth.
If a market developed for the stuff — even if it were priced at a sharp discount — companies and investors could at least quantify the damage to their balance sheets.
E*Trade’s (ETFC) deal with Citadel Investment Group this week is intriguing in this regard. It helps dispel bankruptcy rumors about E*Trade as Citadel injects $2.5 billion in capital into the online broker and banker. (I wrote about the deal on Thursday.)
But also, as part of the deal, Citadel will pay $800 million for E*Trade’s most toxic debt, with a face value of $3 billion. That’s almost 27 cents on the dollar.
So is 27 cents on the dollar the new price for this stuff?
Probably not, for two reasons: First, these debt instruments are extraordinarily complex, and each one is unique. So lessons from E*Trade’s basket of subprime-related exposure won’t necessarily be applicable to the messes on other firms’ balance sheets. Second, the Citadel deal wasn’t a pure transaction. It was part of a broader deal that also gave Citadel ownership of 20% of E*Trade shares and debt payments at a 12% initial interest rate.
However, Citadel’s example may inspire other investors and hedge funds to take a chance on risky debt, hoping for big returns if the mortgage markets stabilize.