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least risky tranches at the top and the more risky tranches with commensurate premiums towards the bottom

it's drawing loans like an age pyramid, except you don't sort by year of birth but by year of default (death). Early years bottom, already defaulted->equity tranche, future years (not yet defaulted) --> up in the senior tranches.

This extra value when siphoned off repeatedly from the overall mortgage pool required an ever larger base of sub-prime mortgages in the new pyramid shape, thus increasing the systemic risk further

Here actually he gets plain wrong, or he's trying to push a point to a laymen audience the wrong way. Once a given loan fund is built to be sliced in new CDO, no more loans are added to it. New loans -> new wagon of funds, tranches, etc... You don't feed new risky loans in a sold out fund.

The nexus that connects the CDO and subprime, is that CDOs enabled bad loans to be dumped on the market. There are not enough buyers for all bad loans if they are all rated junk. The CDO, by putting "watermarks", enables packagers to pretend most of the fund is safe and find buyers for it. So they siphoned Wall Street money into McMansions where realtors shoved illiterate borrowers. And everybody took a fee in the process. And to keep on the promises that borrowers could refi, they had to find more borrowers to keep the prices going up. The ponzi scheme is here, and not in the building of the tranches.


The differences:(snipped)

Totally agree. 1) The behavior of rating agencies was fraudulent, close to Arthur Andersen in the Enron case, and they will face consequences. But this is not intrinsic to CDO slicing, the greed and the low rates have turned US real estate financing into a giant fraud, and the fraud just used the fashionable instruments of the time
2) and 3) Yup, it's a political thing, and the politicians will use the RA as a fuse when they are equally guilty.

Pierre

by Pierre on Sun Aug 19th, 2007 at 02:26:03 PM EST
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