Hacker News Board Hacker News, browsed like a classic message board
Live data from Hacker News

Banks to sell first post-crisis managed synthetic CDO

ifre.com

Post reply on HN
Print view View original

61–70 of 97 posts

Re: Banks to sell first post-crisis managed synthetic CDO

#61

Post by ThrustVectoring »

coliveira wrote: post #54
ThrustVectoring wrote: post #50

This is actually fine. While CDOs were involved in the last financial crisis, they weren't the fundamental culprit. That honor would belong to ill-coordinated banking regulations between the US and Europe. In order to provide a public backstop without encouraging moral hazard, banking regulators impose risk-taking limitations on banks. In the US, this took the form of encouraging asset sales into capital markets, und…

These are all incidental issues. The real problem with CDOs and related financial products is that they deal with tremendous leverage without proper transparency. In a leveraged environment, you need to have a framework to understand who owns what and if the counterpart can pay for that leverage. Good examples of such a well regulated market are the options and futures markets. On the contrary, CDOs, swaps, and other…

Collateralized Debt Obligations themselves aren't a leveraged product. The originating bank issues loans and then sells on the assets. The various tranches are sold for cash and receive varying priority of cash-flow from the original loans. All the leverage is outside of the CDO itself - either European banks buying a dollar's worth of "AAA" assets with 98 cents of borrowed money, or some company writing a credit-default swap on it and backing it with cash worth a fraction of the value at risk.

Re: Banks to sell first post-crisis managed synthetic CDO

#62

Post by djannzjkzxn »

riffraff wrote: post #40
slumdev wrote: post #36

Earlier quoted context omitted.

I've seen the movie and not read the book, and I took away two things: 1. Derivatives can be riskier than the underlying asset. 2. Ratings agencies will lie if it makes a big client happy. I don't think either 1 or 2 is controversial. And put together, those two truths will lead us right back to 2008.

one interesting fact the movie didn't mention about CDOs, IIRC, is that the repackaging makes sense only with the assumption that the underlying assets are independent variables. I.e. if you have 2 independent bonds which will default with 50% probability you can combine 4 outcomes into a single one and issue two tranches. The senior one should be payed back 3 times out of 4 (it's enough if one bond pays back) and th…

Assets don’t need to be completely independent for their combination to provide an improved risk-adjusted return. In fact, all asset prices are correlated, but we still diversify. I don’t think the financial crisis happened because nobody heard of conditional probability. Derivative structuring is one of the places where people who are good at math go to get rich.

Here is an old paper from 2001 that talks about how ratings agencies were using this math: https://www.jstor.org/stable/4480294?seq=1

The devil is in the details - even if you understand the math, you have a lot of choices to make. Ultimately you are going to have to set parameters on your model where the data to estimate the parameter accurately doesn’t exist. And at that point, math suddenly turns into opinion.

Re: Banks to sell first post-crisis managed synthetic CDO

#63

Post by vkou »

nradov wrote: post #57
vkou wrote: post #53

Earlier quoted context omitted.

Defined benefit pension plans are a great idea, because you get something out of them, regardless of how long you live. Even if investing in one makes you take a haircut, compared to a fixed contribution fund, they are still a great idea. For two key reasons. 1. You need money to live. 2. You don't know how long you'll live for. If I retire with a fixed contribution retirement fund, that is planned to last me 20 year…

Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay? It's just too risky and the existence of the PBGC actually exacerbates that risk, creating a huge moral hazard at taxpayer expense. And as for a market crash two years into retirement, only an idiot would be in volatil…

> Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay?

You take a haircut, and your pension ends up getting reduced to ~70% of what you were going to get paid. That's the "Flip a coin, and lose scenario". But at least you're still getting paid.

These funds don't magically drop to zero out of the blue, and neither will social security (Which is the biggest example of a defined benefit pension fund.)

> And as for a market crash two years into retirement, only an idiot would be in volatile assets at that stage. The default investment option for most defined contribution plans is a target date fund, which protects against that scenario.

Keeping all your money in safe, zero-return investments doesn't protect against the scenario of 'you lived longer than expected'.

My parents have recently retired. They aren't keeping every penny of their money in a zero-return mattress. If they did, it would run out when they hit 82. Investment orthodoxy agrees with them - it instructs that when you are 70, you should have ~30% stocks.

If you follow that orthodoxy, and get a recession a bit into your retirement, and live longer than expected, you are going to be old and broke, but I suppose you'll feel really smart for not getting hoodwinked by one of those defined payment pensions...

Re: Banks to sell first post-crisis managed synthetic CDO

#64

Post by csense »

Hopefully by now, everyone knows a bunch of banks bought CDO's, and then in '08 they collapsed, or nearly did, and took the world economy with them.

If you run a bank, and you know this product is dangerous and causes banks to fail, why in the world would you buy one of these products? Maybe you told your brother-in-law to take a massive short position on your bank?

Re: Banks to sell first post-crisis managed synthetic CDO

#65

Post by minikites »

csense wrote: post #64

Hopefully by now, everyone knows a bunch of banks bought CDO's, and then in '08 they collapsed, or nearly did, and took the world economy with them. If you run a bank, and you know this product is dangerous and causes banks to fail, why in the world would you buy one of these products? Maybe you told your brother-in-law to take a massive short position on your bank?

Sometimes the invisible hand of the market is invisible because it's not there.

Re: Banks to sell first post-crisis managed synthetic CDO

#66

Post by qeternity »

csense wrote: post #64

Hopefully by now, everyone knows a bunch of banks bought CDO's, and then in '08 they collapsed, or nearly did, and took the world economy with them. If you run a bank, and you know this product is dangerous and causes banks to fail, why in the world would you buy one of these products? Maybe you told your brother-in-law to take a massive short position on your bank?

They didn’t collapse because of CDOs. They collapsed because GSEs had pushed the real estate market to ridiculous levels. The GFC was a classic case of government interference creating market distortions.

Re: Banks to sell first post-crisis managed synthetic CDO

#67

Post by coliveira »

JumpCrisscross wrote: post #59
coliveira wrote: post #56

Earlier quoted context omitted.

CDOs and similars are the ideal vehicle for financial fraud. Basically it assumes that certain companies can create pools of loans that have well defined risk, and rewards them for finding as many of these loans as possible. It is clearly in the interest of loan originators to create a high number of loans with lower quality, after all they won't have to keep these loans and are paid only on the origination.

> it assumes that certain companies can create pools of loans that have well defined risk No. It says a portfolio of risks can be arranged such that their first cash flows are less risky than their last. This is prima facie true. What matters, to a point, is less the level of risk than its correlation. (And where you draw the line between privileged and unprivileged flows.) Putting it another way, if I take a hundred…

The comparative advantage of certain investors (Bob in this case) is useless if the loans are the result of fraud. I can create a fraudulent loan originator and crank thousands of loans that are worthless, simply because borrowers can't or won't pay the loan. These loans can be classified as AAA, but it doesn't matter. This is essentially what happened in 2008. And to complete the picture, nobody knows who is who, because of the widespread fraud, so while some borrowers will continue to pay, there is no way to know how many, and therefore no way to value that asset class. So, again, the problem with the failure of CDOs is not just its theory, but assumptions about the trustworthiness of loan originators.

Re: Banks to sell first post-crisis managed synthetic CDO

#69

Post by lifeisstillgood »

JumpCrisscross wrote: post #58
coliveira wrote: post #54

Earlier quoted context omitted.

These are all incidental issues. The real problem with CDOs and related financial products is that they deal with tremendous leverage without proper transparency. In a leveraged environment, you need to have a framework to understand who owns what and if the counterpart can pay for that leverage. Good examples of such a well regulated market are the options and futures markets. On the contrary, CDOs, swaps, and other…

> they deal with tremendous leverage without proper transparency At least immediately post crisis, these products were super transparent. You have all the underlying loans and their docs in the closing package. Everyone knows who the ultimate borrower is, and how a dollar traces from them to their point in the chain. As long as these assets are held outside the payments system, the contagion risk is contained. The pr…

So, my take has been that these products were (de facto, of not de jure) insurance products that were incorrectly priced premiums.

If that is right, and as you say they were very transparent, what was it that made this mid-priced? was it simply impossible to insure?

Re: Banks to sell first post-crisis managed synthetic CDO

#70

Post by chii »

vkou wrote: post #63
nradov wrote: post #57

Earlier quoted context omitted.

Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay? It's just too risky and the existence of the PBGC actually exacerbates that risk, creating a huge moral hazard at taxpayer expense. And as for a market crash two years into retirement, only an idiot would be in volatil…

> Most financial risk can't be reduced, only shifted around between parties. The problem with defined benefit pension plans is what happens when the sponsoring entity goes bankrupt and can no longer pay? You take a haircut, and your pension ends up getting reduced to ~70% of what you were going to get paid. That's the "Flip a coin, and lose scenario". But at least you're still getting paid. These funds don't magicall…

The thing is that to prepare for retirement, you cannot have a plan where you accrue a lump sum that you then draw down.

The only plan that can works is if you accrue a large enough amount, from which the interest earnings are enough to sustain you indefinitely (using a low interest but safe returns instrument like high grade bonds and gov't bonds, with a small mix of stocks selected for dividends). The expectation is to earn some 2-4% interest in aggregate, and that should amount to some $20-30k USD per year (after tax, if taxed - preferably work out how to get good tax treatment). That works out to be between $900k-1mil USD.

If you cannot hit this target by the expected time you need to retire, then you're already fucked. That's why retirement planning should start when you start your first job.

Post reply on HN