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The Bubble Has Been Fully Restored: Goldman Is Selling A Synthetic CDO
Earlier this week, Bloomberg ran a story that carried the headline “Goldman Sachs Hawks CDOs Tainted By Credit Crisis Under New Name.” Here’s an excerpt:
“The 2008 financial crisis gave a few credit products a bad reputation.
Like collateralized debt obligations, known as CDOs. Or credit-default swaps. But now, a marriage of the two terms (using leverage, of course) is making a comeback -- it’s just being called something else.
Goldman Sachs Group Inc. is joining other banks in peddling something they’re referring to as a ‘bespoke tranche opportunity’…
The deals are ‘attractive for credit-savvy investors in the post-QE credit picker’s market,’ according to a January U.S. credit derivatives outlook by Citigroup Inc.,
The transactions offer the potential for higher returns than buying a typical corporate bond, especially if an investor focuses on first-loss slices or uses borrowed money.”
This is the latest installment in a series of articles that pop up every so often in the financial news media touting the resurgence of structured credit and, more specifically, synthetic CDOs. The interesting thing about the Bloomberg piece is that it references a Citi note which attempts to make a distinction between traditional synthetic CDO deals and so-called "exotics", such as the much maligned Leveraged Super Senior (LSS) structure, prevalent in pre-crisis Canada.
LSS deals -- which allowed protection sellers to lever up 10X on otherwise unattractive (from a premium perspective) super senior CDO tranches -- were at the heart of an absolutely epic meltdown in the market for third-party Canadian commercial paper back in 2007. This incident precipitated all types of mayhem with unsuspecting retail investors, played havoc with the country’s pension funds, and led several former Deutsche Bank employees to accuse the bank of masking more than $10 billion in paper losses during the financial crisis.
The laughable thing about LSS deals was that they were effectively non-recourse, meaning that the protection seller was allowed to sell protection on a notional amount that was multiples of the collateral posted, but in the event the market moved against the seller enough to chew through that collateral and a margin call was made, that seller could just say “to hell with it” and walk away from the deal. More simply, I, the seller, insure $100 million in debt, but only post $10 million up front. If there’s a credit market meltdown and my $10 million is no longer sufficient and you, the protection (insurance) buyer, call me looking for more money to compensate you for the elevated risk, I can politely tell you to piss off. The risk that I tell you to piss off is called “gap risk.”
Now if you’re the protection buyer in that scenario, you’re likely sitting on a mark-to-market loss and that’s something that some risk managers think shareholders should know about, hence the former Deutsche employees’ contention that in some cases, these losses were not properly accounted for, leading the bank to look healthier than it actually was during the crisis years. The other side of that argument says that it really doesn’t matter because if no actual defaults occurred in the senior tranches, then the losses were just paper losses so, ultimately, who cares? Of course that’s a kind of “hindsight is 20/20” argument that it’s very easy to make years later: “There were no defaults, so there was no need to report the M2M losses.” Much like: “There was smoke billowing out my neighbor’s window and he wasn’t answering the phone, but it turned out he just burned his dinner, therefore I shouldn’t have gone and checked on him.”
The point here is that supposedly, regular synthetic CDOs (and "regular" here just refers to the full-recourse nature of the IM/VM framework and isn't meant to indicate anything about whether the tranches are bespoke) are suitable instruments for, as Citi put it last month, "credit savvy investors," and it was only the unique character of the leverage employed in the LSS deals that led them to blow up. As synthetic credit appears to be making a comeback, it's worth revisiting that assumption.
To be fair to synthetic CDOs, Bloomberg does gloss over a distinction in terms of how “leverage” is being defined in these deals.
Here’s Citi on structural leverage:
“To understand this, consider an equity (0%-5%) tranche that trades at a price of 80 pts upfront with a running coupon of 500bp. In bond terms (fully funded), the investor pays 20 cents on the dollar for a bond and gets paid 500bp coupon till maturity, when par is returned if there are no defaults. The returns are therefore magnified 5x, but if there are defaults, the investor’s losses are limited to the 20 cents paid upfront, i.e., there is no recourse beyond the initial investment.”
So that’s the non-recourse structural leverage built into the equity tranche. So what about good ol’ financial leverage (that’s the fun kind)?
Here’s Citi again:
“In addition, it is possible to get financial (or swap) leverage on tranches through an initial/variation margin (IM/VM) framework – this is full recourse and can further help to magnify returns. In this case, the investor puts up collateral for a fraction of the original notional at trade initiation (initial margin), but the margin is adjusted upwards if the market moves against the investor (variation margin).”
For example, here are some IM assumptions Citi used for modeling purposes:
Note that Citi is quick to explicitly note that this leverage is not the same as the leverage that was employed with the LSS deals that imploded in Canada in 2007:
“...and super senior risk (with spreads in the single digits) was only attractive if the investor was able to apply financial leverage. This produced exotic structures such as the leveraged super seniors, which eventually resulted in the demise of the Canadian conduits.”
So why exactly were the LSS deals “exotic structures” (suggesting they are wildly different from other structures) whereas other synthetic CDO deals are seen as traditional and therefore more suitable investments when both involve the posting of collateral that is only a fraction of the notional amount insured? It comes down to whether the deals are non-recourse or full-recourse. In other words, with LSS deals, the investor can simply walk away in the event of a margin call and in traditional deals, the protection seller is obligated to post more collateral.
Here’s an excerpt from a Euromoney piece (which ironically discusses a deal Citi was pushing a few years back) which explains the distinction:
“Citi in its latest deal has introduced a feature that gives it full recourse to the investor, removing the option to back out. That means whatever the market does, Citi can still collect on its insurance, effectively swapping gap risk for counterparty risk.”
So in sum, we should all feel better about these deals because now they’ll likely all be full-recourse and instead of gap-risk, the structures only create counterparty risk.
Of course this is all just semantics. Sure, all things equal it’s better to be able to sue your counterparty in the event they don’t meet a margin call as opposed to not being able to sue them, but in a crisis, what’s the difference between a protection seller walking away from a deal because they can and a protection seller walking away because they’ve blow up and can’t meet the margin calls?
At the end of the day, the idea that a “traditional” (whatever that means in the context of synthetic CDOs), full-recourse framework makes the use of leverage safer in synthetic CDOs seems to miss the fact that it was counterparty risk that blew up the system in the first place.
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There are no more idiots left. Everybody knows the game. Nobody will buy them
Plenty of idiots still around. Otherwise known as GS clients...
Who says the fall of the Roman Empire couldn't have been stopped once begun? We just did it. Too bad they didn't possess our advanced financial technology.
Chariots of Fire, bitchez.
https://www.youtube.com/watch?v=RY3XiM7oGj0
Bitchez.
"‘bespoke tranche opportunity’"
What, a BTO? Takin' Care of Business, I see.
"Let it ride", baby!!
We can't reset this thing until people learn to stop buying bad debt.
"I've been doin' things worthwhile, and you've been bookin' time
Try, try, try, let it ride"
Returns are higher on borroewd money? Now there's a great one...who thought up that one? Think the Fed had a little influence here?
You ain't seen nothin' yet....b-b-b-baby.
BTO 1974?
I am not smart enough to understand all this. But to me, it introduces complexity where none needs to be.
It seems to me that as long as the institution can take a position against their clients, I HAVE TO ASSUME that they are aimed to take advantage of me and I will not make use of that institution.
Bring back Glass-Steagall or I don't deal with anything more complex than Credit Unions
I completely agree with you, with one little quibble.
This introduces complexity where it's absolutely necessary. If these transactions were simple, nobody would touch this shit at anywhere near the offered and hoped-for price. No sales = no commissions or bonuses, nor enough leeway in the spread to make money getting in on the other side of the deal to fleece the muppets.
So without the complexity, there's no point doing it. It's absolutely necessary.
The rest of your comment is spot-on.
Complexity and opacity allow the Vampire Squid to make a killing selling shit to their unsophisicated clients.
Fractional reserve banking itself introduces complexity where it need not be. This is just another layer on the pyramid.
In other words, if you can't dazzle them with your brilliance, baffle them with your bullshit to get them to sign on the dotted line.
X......................................................................................
So, if I understand you, complexity should be an indicator of two things:
1) Stupid firms using it.
2) Firms using it to take advantage of their customers.
Both reasons I should avoid it and the firms that use it.
Herein lies the problem with trying to stop these products, you are not fighting the criminals, you are fighting with hoars of stupid muppets trying to to make "moar" money faster and faster. Unlike forest fires, there is no solution to stupidity.
"GS Clients"
As a primary dealer, there's ultimately little way to avoid them. That's the problem. I don't know, but I been told that's why they're affectionately known as The Squid. If they actually had to compete for clients, then we might have something.
People have a shorter memory than you seem to think
If synthetic CDOs are anything like synthetic oil, the rust-bucket economy can get another 100,000 km.
I think a better analogy might be replacing the oil in the crankcase with nitro fuel.
Damn it feels good to be a banksta......
muppets and sheep are still here and they will buy all shit presented by usa whores in zombie-box
"Zombie Box" Is that anything like a Monster Box?
ekm1, you sometimes seem wise but sometimes...not so much
Nobody will buy them, nobody.
Before one could justify buying them for being misled.
Not now. No manager will risk going to jail, unless fully hedged
ekm1, unfortunately they won't know that they bought them. They will be bought for them by those who are told to buy them.
Nope. They can no longer claim "ignorance", the buyers I'm talking about.
Judging from recent history, jail does not enter into equation.
Jail, what the fuck are you talking about? Name one that is in jail now.
Man, talk about giving yourself away.
Did you read what I said?
They claimed ignorance in 2008.
They cannot claim that now.
Jail is coming if it happens again. It won't
Yeah, but even when it's proven that they weren't ignorant, at least in the case of "one shitty deal", still nobody went to jail. So no, I have to respectfully disagree with your assessment.
I have participated in several ponzi schemes at once in eastern europe.
It doesn't work after people learn the game.
It's over for bank lobby. Customers learned the game.
Bernie Madoff
One out of how many thousands that deserve it ended up in jail.
I thought that's what pension funds were for . . .
Hey guys.. forget about tranches, buy my SHIT SANDWICH, it's got a savoury coating and is filled with 100% pure turd -
</honesty>
Oh yeah? They're already sold dude
There are plenty of seriously underfunded pensions out there that will do anything for yield, no matter how desperate.
And a few hookers-and-blow excursions courtesy of GS will have pension managers signing on the dotted line.
I remember the Russian Sergei Mavrodi who openly ran Ponzi schemes.
People knew what it was, but they still gave him their money because they thought they could get out before it collapsed.
Different ball game.
I have played in ponzi schemes personally, fully knowing it was ponzi.
But this is on national scale covered by media. Not the same
In 2008, ignorance was claimed.
They cannot claim that again. Jail coming.
@ekm1,
always appreciate your perspective. while i can't say i agree, i can say i hope & pray you're right in your assessment.
i just don't see jail for evil of this magnitude.
Nobody can claim 'ignorance' now.
Jail of fund managers coming if repeated again. There is abundant information on main stream media now for them to be sent to jail.
"Ignorance" does not cut it any longer
what you are saying is true but , make no mistake about it no big fish will go down (just medium and a lot of small get fried)
Goldman guys wil say: Read the fine print.
Fund manager will go to jail, if they buy
we are on the same page
You said there are no more idiots left; my point was that there are plenty of idiots who think they are smarter than everyone else.
Jail? I would settle for a ramp in banker suicides personally, but starting at the highest tiers of the banker elite, not some regional officers. Plenty of nails, tal buildings, and opiods around.
Ahh yes Market "timing" !!
you're wrong
the mother of idiots is always pregnant
Yes, and the father of idiots is always...
Ponzi works only when most people don't know about it.
Now all know about it.
It no longer works.
There's a sucker born every minute
-P T Barnum
I appreciate ur comments, but ur wrong: do not underestimate OPM and 200 West has all of the biggest ones as clients.
VICTORY
Can I get a 0% loan from Wells Fago to buy some of these?
no.
I know, it's HuffPo, but it illustrates how WF does business.
http://www.huffingtonpost.com/2012/04/09/elizabeth-magner-new-orleans-we...
No but Wells Fargo will have "Linda Green" sign dox saying they lent you money and foreclose your home.
Ah, it's great to be home again.
The ride down is always exciting...
WHEEEEEEEEEEEEEEEE!
Fred Reed explains Economics, just posted.
Fred is a national treasure.
Great. Another vehicle where TBTJ will abuse asymmetric leverage and knowledge of positions, this time with the added benefit of seeing margin calls along the way... More visibility into how to steal from those without control of the effective money supply.
You know, I don't blame Goldman Sachs for selling these toxic products.
What I resent is that idiot bankers will buy this crud, fail (because they didn't know what they were doing) and then, get bailed out.
In fact, I was thinking the other day, if another financial meltdown happens and governments do another taxpayer bailout again. Will the rank and file get REALLY mad this time? Or will we just roll over and die? If we choose the latter, then maybe we're to blame.....?
Those buying that stuff obviously have waaaaaay too much money. Fuck 'em.
played havoc with the country’s pension funds
Financial Capitalism has an animating philosophy: The idea is to privatize the commons and take perpetual tolls. It's great to be the king and have pebians give fealty to me (since I'm superior and so are my in-group progeny) in the form of perpetual rents.
Virtually all of the SPV, MBS and other financial vehicles private banker brain trust cooks up, are to financial capitalist benefit. The Casino, or house, always wins. They will manipulate LIBOR, or pay-off government, or get law changed. It is a full time job just keeping up with their antics.
At some level, they must know they are predators. We know that a high percentage of people on wall street are psychopaths.
So, what is in their heart that encourages psychopathic behavior? Some of it can be blamed on an ancient religion that gives cover, acts as a shield, and secretly acts as an in-group sword for this psycopathology. Many of us know which religion that is.
The other part is greed, wanting to live off of the fat of others. Greed is related to the pride defect of man. Those of us who would like to eliminate the pride defect from civilization are thwarted at every turn by this religous thought construct. Secret private money power, coupled with animating pro-rentier philosophy, can only have bad outputs.
It is good to have Maria servicing me while Manuel mows my grass. If it happens simultaneously, then BONUS. Meanwhile my kids don't learn how to mow lawns or learn the value of work. They end up thinking that people are born to a class. Rent seeking behavior has many negative knock on effects, and keeps man from evolving.
If we humans do ourselves in, it is because we didn't have the sack to deal with false predator religions along with their private money power constructs. We also allow psychopaths to walk amongst us, especially when we now have brain scan technology to determine who they are.
Not sure what religions you're referring to there, but any one of them could be worked to good ends, in my athiest opinion.
You nail the problem in your second conclusion, though. Unfortunately, there is no reasonably reliable brain scan technology to identify "them." That's a scam run by "neuropsychologists" and neurologists these days. If only it were that simple.
Corruption accounts for the majority of the variance.
Nurture is a bitch in a neoliberal world.
https://en.wikipedia.org/wiki/Neoliberalism
Tyler is busy this weekend and I mean by his(their) own posts rather than a guest post shout out.
Shit is starting to heat up...
The best content on ZH is always the locally generated stuff. I think the issue is there's no way they could have the update rate anywhere near where it is with only local content though.
Could this hurt some equities or would the money into this come from all that sidelines money that was waiting on higher interest rates?
Who's going to buy this shit?
Norway Teacher's Pension Fund
Calpers
TIAA-CREF
etc.
goldman has plenty of clients, the clients manage huge amounts of money in pension funds, public, teaches, etc. they visit new york once a year, they get wined, dined and strip club visits for free. they meet goldmine's 'smartest' and get to round around and told how smart 'they' are. they are then invited to invest in a great opportunity to help them get some 'kick' into their portfolio. yes, its' risky, but goldman put it together, there is nothing to fear.
goldman only does the best for their clients, they put this stuff together, and have NO influence on the outcome, they would NEVER take the other side of the bet. for example. ask AIG.
Give a man a fish and he will eat for one day.
Teach a man to fish and he will eat for life.
Let a Goldman Bankster fish and he will trespass on your property, catch all the fish in your pond, sell them to the highest bidder, and you you will starve to death.
Everything is wrong with the underlying "asset". Your debt is someone else's "asset" why do they feel comfortable with leveraging debt against debt collaterol?
Lock and Load, Gentlemen
As if there isn’t enough risk in the financial markets already, these people go out and create more out of nothing but thin air.
As much as I hate these guys you simply have to admire their chutzpah.
Now if only any of us had any money left to invest.
Synthetic CDOs right. Not even the wild man of Borneo would by that crap.
This time it's gonna be different!
https://www.youtube.com/watch?v=MMR5JVo21wQ
How about we just play with money that actually exists. Wouldn't it be easier?
Synthetic by nature is a claim the product is not real. If my wife walked in with DDs tomorrow I would know they were fake. For a minute I might be happy looking at her with her clothes on, but once that shirt comes off and I see the lumpy scarred mounds of synthetic flesh, I would be sick. Just like what is packaged as a synthetic CDO.
Can we just call it a sick fuckers fantasy and be done with it?
Oh I forgot, just like retail, 90% of what they claim is pure bullshit and Mr 1% can't pay himself $100 million if business plays by the rules. They need this crap to grant themselves the money they think they deserve.
The world needs to conjure $100 trillion out of thin air every year to make it look like the banksters know what they are doing.
If one were to invest and get some kind of gain, would that gain be "synthetic?"
Some thing tells me Michael Burry is looking into the details of this toxic junk.
I think I was just violated mathematically. I'm gonna need a flow chart.