If I could entirely grasp this account of the first collateralized debt obligation, I would understand everything. (And if you can, please come work here!) However, I do understand the phrase "the next shoe to drop," so it is worth reading this piece by Felix Salmon all the way to the end even if your brain smokes a little in the middle.
Nassim Taleb cleared this up for me once. "It's like buying insurance on the Titanic from someone on the Titanic"
and sometimes credit default swaps are like buying insurance on the Titanic when you're the iceberg.
Liar's Poker has a couple of surprisingly timely chapters that cover the invention of mortgage-backed securities, if i remember right.
is that a smoked Salmon joke? I like it.
First I have to be less stupid.
Ran across a piece by Anna Quindlen (yeah, yeah) in a month-old Newsweek yesterday, while in the waiting room at the hospital (hospitals are good for such things). Boiling everything down to a truism that 90% of our problem is that nobody understands the math of any of this shit.
I tried to read Felix's Wired article on a plane, but it got sucked out the window. This is all hopelessly beyond me.
What it all means is I put my money in a mattress until now I get to sleep on the floor.
I spent a year "dealing" with CDO's. Suffice it to say that the two words I'd use to describe them to lay people: smoke and mirrors.
That is an excellent summary!
So... we're eventually fucked, right? I didn't read the article, but I think my previous statement holds true regardless of circumstances.
So a bunch of municipalities might go under?
Finally, I have a chance to purchase a small town and become a small fry Mr. Burns.
Pray it's not your town.
No. What it means is that municipalities will run out of money and default on their bonds. This will be calamitous for the town's credit rating, but the town will not go away or be put up for sale.
Though, if that were a potential or likely outcome, I could finally make good on my high-school promise to buy my hometown and obliterate it as a spiteful act.
I dunno why anyone would invest in munis anyway. Have any of these investors been to a local council meeting? Have you seen who gets elected to municipal office in this country? I would rather my money be in the hands of an angel dust user.
The whole thing started to smell when you could buy protection on single name subordinated subprime RMBS from the seller who was now synthetically long a triple BBB porfolio of names he could then make a synthetic AAA CDO out of and name it after his dog.
I really kind of went DOA on BFD.
Oh hey I'm experienced. I'm also the antichrist, as my response will demonstrate. Here's the key thing he's wrong on:
"In other words, there’s a very serious, and pretty much impossible to hedge, risk of snowballing muni defaults."
I don't agree, because I think regulators will be swift to act under the whips and chains of institutions and wealthy private interests. You'll see the death of local governments before you see the death of everyone who funds muni bonds. Because the bondholders, who are pretty much invariably rich and well-connected, will rise up and slay the 50k-a-year chucklefucks running most of our cities and towns toward financial ruin with poor planning and kickbacks.
Of course, a few munis have already started doing the default thing. But they've been doing it to teachers and stuff when they try to collect pensions. You can't pull that shit on rich people. Everyone talked about this a lot last year:
http://www.muninetguide.com/articles/Vallejo-Bankruptcy-Filing-Garner-282.php
Like, you know in The Wire how all the politicians seemed to be clueless assholes who spent a whole lot of money on absolutely nothing? Now imagine that the people who actually provided that money ceased receiving interest on all that backroom fuckery. That's when the fuckery stops, ladies and gentlemen.
But didn't dude say that that would only happen in case the bonds weren't insured? There was a lot of smoke in the room at the time...
As the AIG experience teaches us, BOND INSURANCE MEANS FUCK-ALL.
Even if you run around frantically insuring munis way too many of them will get preferential risk ratings. The only way to save the abysmal "real" credit ratings in most local governments is to raise local taxes. Ha ha ha ha ha ha. Can you imagine the ridiculous little tea parties in Tyson's Corner or Cheboygan or something? Followed by schools with no books or running water ringed by destroyed roads and smoking powerlines?
the reason you can fit 10B in into a 700mm CDO is something called over collateralization. You have 7% (or whatever amount) income coming in on the 10B asset (700mm) and is funneled through to the CDO holders, but the CDO has been structured to only pay the holders 5% (500mm) thus you're over collateralized by (wallah) 200mm. You could theoretically (yes there in lies the rub) have 200mm in defaults before it ever affected the payments to the CDO. This is how they got the AAA rating.
In the case of munis, they are not rated on the same scale as corporations and sovereign debt. AAA in muni land does not mean risk free, only that t's safer than AA rated paper and so on. Muni ratings are relative while corporations and sovereign debt are rated on probability of default (modeling again). Moody's is working on this issue
It really sucks that rich people can be careless about their investments, stupid with their money and get saved. Meanwhile, I manage my little portfolio to death, and still get screwed. Time for the mattress.
Oh gosh, this reminds me of the old days of Municipal Industrial Revenue Bonds, when all those I-Bankers and the Bond Counsel would sit around at a closing going "yadda, yadda, yadda, placement this, placement that, what do you mean there's no first class left whore, etc." I had no idea what they were talking about, and yet I was still papering the deal for one of the so-called risk holders. Putting that aside, if you have crap assets at the bottom of the food chain, you can't magically dustbuster away the risk associated with them. You can sweep it all under the bed and pretend it's not there, but you'll start sneezing eventually. Badda badda bing. I should ghostwrite for Maureen Dowd.