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Banks to sell first post-crisis managed synthetic CDO

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

#71

Post by vijayr02 »

ThrustVectoring wrote: post #61
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…

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-def…

This is not a regular CDO - this is a synthetic CDO.

The 'synthetic' means that the issuer may not (and most likely does not) hold the risk being tranched (loans in your example). Instead it generates return by selling CDS protection on certain market defined risks (hence the word synthetic, in the sense of being a derivative exposure).

This makes a big difference:

1. Since individual tranches can be created on demand (unlike a regular CDO, where the full capital structure has to be placed), banks can create bespoke standalone tranches which are then hedged based on a correlation model. Thus there is much lesser market feedback to put a brake on unbridled issuance. A (very) loose analogy would be insuring your house (i.e. needing to own the loan under the CDO) and betting that your neighbour's house will burn down (where you have no skin in the actual asset). You can clearly do much larger sizes of the latter contract, for the first one, you need to buy a house each time you want to put the trade on.

2. The CDO invests in collateral to back the protection sold. One of the issues during the crisis was that this collateral itself was other CDO tranches (either synthetic or physical). When the market melted down, these assets became unpriceable given the opacity of the collateral. Result = even higher illiquidity

Of course the issued size is nowhere near becoming a systemic problem similar to 2007, but it does seem that those who do not learn from history are condemned to repeat their errors.

In this context Raghuram Rajan's speech at the 2005 Jackson Hole symposium is especially prescient: https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp0827...

Edit: misread JumpCrissCross's reference to payment processors as protection buyers, deleted this part.

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

#72

Post by vijayr02 »

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…

Again, only true for regular (non synthetic) CDOs - this is where the issuer is a dumb (or managed) vehicle that buys loans and tranches them up. The best example today would be Mortgage Backed Security (MBS) tranches / Asset Backed Security (ABS) tranches. AS you say, if the intermediary is suspect the structure can become suspect - but this can be fixed by appropriate structuring and security.

In a synthetic CDO the cash raised from CDO issuance is invested in collateral (more often than not, chosen for highest return rather than real safety), and the investment return is generated by selling protection on CDS - the terms of this CDS may not always be very clear. If you have sold protection to Lehman for example and they go bust, your structure is in limbo, without a single underlying having defaulted.

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

#73

Post by vkou »

chii wrote: post #70
vkou wrote: post #63

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? 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 i…

> 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).

I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most people can't afford to save that up.

What I, and most people need is a plan that will sustain the retiree until they die - and not just for an average case scenario.

Pension plans have lower expected returns, but handle the long-tail cases well, because they balance risk between different participants - some of whom die early, and some of whom die late. Someone who dies five years after retirement will draw much less from a pension than someone who dies twenty five years after retirement. The existence of the former provides safety for the existence of the latter.

401Ks have higher expected returns, but handle long-tail cases poorly, because there is no diversification of risk for the individuals participating in them. I may end up dying with 90% of my 401K in the bank. That does me no good. I may end up saving up to live into my 80s... Only to discover - too late - that it wasn't enough.

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

#74

Post by vijayr02 »

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…

If that is the case why were so many US entities victims of the collapse?

1. AIG 2. WamMu 3. Merrill 4. All the monoline insurers (MBIA etc.)

In my view, your comment is just one part of the (v complex) set of conditions leading to the financial crisis. There were also:

1. Substantial savings from mercantilist economies (China / Germany) driving a glut of malinvestment 2. A regulatory view that financial complexity always reduced systemic risk 3. A central bank seen as overly accomodative of speculators (the Greenspan put)

“The world has enough for everyone's need, but not enough for everyone's greed.” - Mahatma Gandhi

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

#75

Post by chii »

vkou wrote: post #73
chii wrote: post #70

Earlier quoted context omitted.

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 i…

> 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). I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most pe…

> That is overkill, and most people can't afford to save that up.

If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings).

Is $500 a month of contributions a lot? I dont know - it depends on your income. But i think for a large portion of the working population, this is doable. It does mean sacrifice if your income is on the low end - you don't ever go on a holiday, you don't drive a new car (but instead, buy an old one so you don't have debt to service). You probably won't own property, and will continue to rent (and i'd include rent costs in the $25k in retirement cost per anum). It's not a fancy lifestyle - but it does mean you don't rely on a gov't social security, you don't rely on a pension fund that could go away.

And the end result is you will have some money left over when you die to contribute to either your children if you got any, or choose to donate/contribute to a cause you find worthy.

Under a pension plan, the person who dies early then leaves their children behind with nothing (or lost the contributions they would've deserved had they remained alive - albeit subsidizing somebody else's longer life). I don't find that fair, since a pension is part of your employment compensation, and yet you don't extract it all if you died, and thus you actually lose out.

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

#76

Post by xchaotic »

chii wrote: post #75
vkou wrote: post #73

Earlier quoted context omitted.

> 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). I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most pe…

> That is overkill, and most people can't afford to save that up. If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings). Is $500 a month of contributions a lot? I dont know - it depends on yo…

Setting aside $500 every month in your 20s for a maybe event in your 80s is an unrealistic expectation for most of the population outside of Bay Area

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

#77

Post by vkou »

chii wrote: post #75
vkou wrote: post #73

Earlier quoted context omitted.

> 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). I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most pe…

> That is overkill, and most people can't afford to save that up. If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings). Is $500 a month of contributions a lot? I dont know - it depends on yo…

> Under a pension plan, the person who dies early then leaves their children behind with nothing (or lost the contributions they would've deserved had they remained alive - albeit subsidizing somebody else's longer life). I don't find that fair, since a pension is part of your employment compensation, and yet you don't extract it all if you died, and thus you actually lose out.

Yes, that's the point of a pension plan. It's not a 'inheritance savings plan'. It's not intended to support your aging adult children. It's intended to support you... So that they don't have to.

What's really unfair to your children is you living to 90, and expecting your kids to support you, when they are 70, because your 401k money has run out five years ago. That's going to do wonders for their retirement prospects, no doubt.

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

#78

Post by 8note »

chii wrote: post #75
vkou wrote: post #73

Earlier quoted context omitted.

> 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). I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most pe…

> That is overkill, and most people can't afford to save that up. If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings). Is $500 a month of contributions a lot? I dont know - it depends on yo…

if landlords find out everyone is putting away $500/month, you can be sure rents will go up by $500/month

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

#79

Post by Gibbon1 »

chii wrote: post #75
vkou wrote: post #73

Earlier quoted context omitted.

> 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). I don't plan to stay alive indefinitely, though, so I don't need a plan that will sustain me indefinitely. That is overkill, and most pe…

> That is overkill, and most people can't afford to save that up. If you start when you're 20 (so 40 years of compounding time for a retirement age of 60), a $500 monthly savings contribution, on a 5% growth of stock investment (which, tbh, is low for such a long period), should net you some $745k (with $240k contributed, $500k interest earnings). Is $500 a month of contributions a lot? I dont know - it depends on yo…

> Under a pension plan, the person who dies early then leaves their children behind with nothing

Someone doesn't understand survivors benefits.

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

#80

Post by Craighead »

qeternity wrote: post #66
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.

Weird, why would indiscriminately layering traunches of risk to fool ratings agencies not be considered the problem?
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