BS Collateral Sale

I've read a lot of the press, but really interested in comments from anyone who may trade or structure these products. Thanks.

"the market is aware of the problem, and has mainly absorbed it", some others said something about the yen carry-trade (????)

Heh that would be me. I guess I should explain further: I was commenting on the price action that day alone and how it wouldn't be wise to attribute one factor as the market mover (and gave an example of what most of the guys I talked to though was the biggest mover that day).

I actually did note in my post how credit is a big mover of the equities market nowadays (using the carry as a proxy). And yea, taking a macro perspective, i do agree that credit shocks is a big things to look out for.

The current condition of the credit market is like a self reinforcing cycle. The credit market is being used to finance investment in other areas (equities/Re/whatever) which in turn rises which in turn influences investors to take out more credit and invest etc etc. You hit it right on the head that a catalyst will occur which will break this cycle. What remains to be seen is whether the market counts the BS collateral sale as the back breaker (which as I pointed out...I doubt because I do not think any of the banks want a stampede and jeopardizes themselves).

But the problem with this strategy is that it is in some sense skewed: you are paid ~450000 to sell protection for 10000000 (in the CDS case, to make it easier).

Heh thats in vogue these days. People have lost all common sense. Everytime I browse through a CTA/HF database I am astonished by the number of options premium selling strategies. It seems to be the same in this space as well. People love the "consistency" of earning these payments in such low vol environments. Blood will flow when shit hits the fan.

np with you trdr1...just the other guy that said his bshit and then left:P:P;););)...

I understand what you are saying. Isn't this a similar situation to the LTCM and the 1998 Russian default debacle, though? Haven't these banks (some of which almost failed back then) learned to impose stricter risk management on their prime brokerage services. Don't they demand their swap counter parties (hedgies) to post collateral for their $10MM insurance policies? They should also have some idea of the leverage these firms employ. Just curious on what you have seen.

Also, it seems recently that the capital markets have become much more resilient and important. They have survived the Amaranth blow-up, GM and F downgrades from IG to Junk, and now possibly subprime (holding breath). Doesn't having this risk spread out among more parties help reduce the risk of large systematic credit events? Couldn't we just see spreads widen ... not liquidity dry up? One could imagine a bank failure if any of these recent events had happened in the past (without so much securitization).

Finally, my original question was centered around CDOs. There has been a lot of public discussion that Rating Agencies are effectively underwriters and have been reluctant to downgrade many tranches because of their position in the underwriting process. Could someone comment on fears of RAs folding to pressure and starting to downgrade massive amounts of issues? Are hedge funds stating these things at true value on their books, or are they waiting for RA downgrades? How has new origination been holding up?

Lots of questions. Thanks in advance for your input.

the situation is VERY different than LTCM and Amaranth. e.g. in LTCM the problems were the fate of a derivative contract if a party defaults and the subsequent global liquidity dry-up, because LTCM had some hundred of billions under management through a leverage ratio 100 to 1. Add to that the derivatives markets were pretty much immature in 1998. Such problems are not case now. The effect of a collapse of a hedge fund investing in complex, illiquid credit products is not direct. Will it impact global liquidity directly?certainly not. Will it make investors more risk-averse?maybe but not a decisive factor. The problem is that if you see a 100mm transaction on an illiquid CDO priced at x, through the asset auction, and the CDO total issue is worth 10bn, the entire 10bn will be automatically subject to a mark-to-market under price x. This way 100mm have an impact on 10bn. This is the problem in loose terms; now you can see the different nature of the problem.

And yes, credit risk is spread to more parties, but here you have to remember the contagion effects from the LTCM crisis; when markets are calm you can claim that you can make the correlations in your portfolio->0. In a crisis though, correlations-->1. Thus when a crisis bursts, it will bang the shit out of everyone.

As far as the last question is concerned it's the first time I hear that...How can RAs be effectively underwriters?

Thanks. I do understand what you are saying. Have you started to see any of this repricing? If Hedge funds plan to hold these things to maturity, will they even attempt to mark to market or will they just classify the securities as HTM and keep them on book at cost or what their model is telling them?

The Hudson Institute recently released research that attacks RAs for their largely interactive role in structuring CDO tranches (as compared to corporate bond issues). The paper goes so far as to say that by SEC/Congressional guidelines, they could be considered underwriters. This could expose them to some liability. Their website is not working properly, or I could include a link to the publication. Instead, I have a couple links to articles/website referencing it.

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajs7BqG4_X8I

http://www.minyanville.com/articles/BSC-CDO-collateral-credit-rating-agencies/index/a/13171

http://www.economist.com/finance/displaystory.cfm?story_id=9267952

I guess my biggest concern is that we could see the Rating Agencies start to downgrade on a large scale, possibly dragging some IG stuff to Junk, forcing some pension funds and others out of the market.

http://www.typepad.com/t/trackback/711782/19475238

Broken link, can you repost?