Oh My F**king God, They're Doing It Again
Submitted by QTR's Fringe Finance
Assholes who wear Vineyard Vines all summer on Wall Street have once again put those Wharton PhD’s to good use by again “discovering” that assets so toxic and illiquid they make drinking cement taste like Fiji water apparently become safe when you rearrange them, rename them, and place an insurance company between the losses and the people buying them. Sound familiar?
According to Bloomberg, UBS and other firms have been exploring structures that package stakes in private-credit funds into bonds. Because perpetual private-credit vehicles do not fit neatly into conventional ratings models, bankers are looking to add insurance “wrappers” that allow portions of the deals to inherit the insurer’s stronger credit profile. The resulting paper can then be marketed as investment grade, even though the assets underneath remain opaque, illiquid private-market investments.
This is apparently considered innovation. I just hear Anthony Bourdain explaining CDOs during The Big Short over and over again.
An insurer guarantees a tranche against losses, the tranche receives a better rating, and other insurers can buy it while setting aside dramatically less capital. In the example described, an A2-rated tranche could require less than 1% in regulatory capital, compared with a charge that could reach 30% for a direct investment in a private-credit fund.
Nothing says “rock-solid asset” quite like needing several lawyers, a ratings agency, an insurance guarantee and a regulatory-capital loophole to explain why it is safe.
The comparison with 2008 is not merely rhetorical. Before the financial crisis, Wall Street packaged mortgages into residential mortgage-backed securities and collateralized debt obligations. Those securities were divided into tranches, and ratings agencies assigned extremely high grades to senior portions based on assumptions that nationwide housing losses would remain limited and geographically dispersed.
Then Wall Street added another layer of genius: credit-default swaps.
Insurer AIG’s Financial Products division sold enormous amounts of CDS protection on mortgage-related securities. These contracts operated much like insurance, promising payment if the protected securities suffered specified credit losses. AIG collected fees up front and initially posted little collateral because everyone treated the company’s high credit rating as a substitute for cash.
The crucial clarification is that AIG’s traditional state-regulated insurance subsidiaries were not simply writing ordinary homeowners policies and accidentally destroying civilization. The catastrophe grew largely inside AIG Financial Products, an inadequately regulated derivatives business that used the broader AIG organization’s pristine rating to guarantee complex financial bets.
But that rating was the magic wand...(READ THIS FULL ARTICLE 100% FREE HERE).