Thursday, March 5, 2009

Failed CDOs

"Amost half of all the complex credit products ever built out of slices of other securitised bonds have now defaulted, according to analysts, and the proportion rises to more than two-thirds among deals created at the peak of the cycle. ... So-called CDOs of ABS caused huge losses to banks such as Merrill Lynch, UBS, and Citigroup, which held large amounts of the supposedly safest top-rated chunks of them. They have since been damned by bodies such as the Bank for International Settlements as being too complex to risk manage effectively. ... However, the ratings of these deals proved unsustainable, as evidenced by the fact they have accounted for 92.9 per cent of all 16,587 ratings downgrades globally from all rating agencies since the beginning of last year, according to Mogan Stanley. The way these complex and risky transactions were exploited at the peak of the bubble can be seen in the data from analysts at Wachovia, , who reckon that 47.6 per cent of alll CDOs of ABS by volume issued since the market substantively began in 2002 have by now hit an event of default. ... However, the real peak of the market saw 147 deals done in the second half of 2006 and 172 done in the first half of 2007--of which 68 per cent and 76.2 per cent respectively have now defaulted", Paul Davies at the FT, 11 February 2009.

"The financial engineers are at it again. ... 'Airplanes fail, too,' says Peter Cotton, founder of Julius Finance, a structured-finance firm in New York. 'That doesn't mean you don't fix them.' Mr. Cotton is one of many such engineers trying to solve a seemingly intractible problem before the government: how to design a system for buying up assets shunted into a massive 'bad bank.' The government doesn't want to pay too much and banks don't want to sell for too little. ... Cotton says the models most banks and ratings firms used to price CDOs were poorly designed. 'They are superficial,' he says, and often spit out prices that don't capture the underlying value of the assets.' ... At Julius, he has been designing new systems that dig deeper into the underlying loans of CDOs. The models use a variety of data points crucial to valuing these assets, such as the relationships between underlying slices of debt with different maturities in the assets. For instance, a CDO contaning many slices of corporate debt, or derivatives tied to that debt, can be priced by looking at where a large number of baskets containing these assets are trading and implying the behavior of the slices from these prices. ... Other financial engineers are working on new methods to price troubled assets. Richard Field, managing director of structured-finance firm TYI, has designed a system that provides real-time loan-performance data investors can consult to more accurately price the securities. If investors can peer into the underlying loan-performance of their aseets on a daily basis, they'll have a much better idea of their present value, Mr. Field argues", Scott Patterson at the WSJ, 23 February 2009.

Who is surprised by this except for the rating agencies?

See my 12 December 2007 and 9 May 2008 posts

1 comment:

Anonymous said...

From your May '08 post...

"R&R Consulting's Ann Rutledge has two good posts at her blog, on 15 March and 5 April 2008 concerning securitization economics. She describes "five preferred (often inter-related) ways to mask the true credit condition of a structured bond". Unfortunately the system was gamed for years."

And the financial firms which did this garbage are the ones we are bailing out now? No... no... no... let the sunshine in... lots of all the windows...