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From what I understand of CDO/CDS from reading too much Michael Lewis, they were designed to avoid the regulatory structures which surround proper insurance.

Portfolio - Michael Lewis - The End of Wall St

After taking a fee, he passed them on to other investors. His job was to be the C.D.O. "expert," but he actually didn't spend any time at all thinking about what was in the C.D.O.'s. "He managed the C.D.O.'s," says Eisman, "but managed what? I was just appalled. People would pay up to have someone manage their C.D.O.'s--as if this moron was helping you. I thought, You prick, you don't give a fuck about the investors in this thing."

Whatever rising anger Eisman felt was offset by the man's genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.'s; he saw it as a basis for friendship. "Then he said something that blew my mind," Eisman tells me. "He says, `I love guys like you who short my market. Without you, I don't have anything to buy.' "

That's when Eisman finally got it. Here he'd been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren't enough Americans with shitty credit taking out loans to satisfy investors' appetite for the end product. The firms used Eisman's bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn't create a second Peyton Manning to inflate the league's stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"



keep to the Fen Causeway
by Helen (lareinagal at yahoo dot co dot uk) on Mon Mar 12th, 2012 at 04:02:40 AM EST
[ Parent ]
Good article.

As I have learnt on ET CDO and CDS has very little in common, except being scams that start with CD. CDO is a way to divide the cash flow from credit and pretend that the debtors can not possibly fail to deliver all on the same time, even if the credit is all crap to begin with. CDS are (apparently) a bet on if a credit will pay or not. So I guess you can take out CDSs on CDOs too, if you want to maximise your scamming potential.

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by A swedish kind of death on Mon Mar 12th, 2012 at 09:59:47 AM EST
[ Parent ]
I guess you can take out CDSs on CDOs too, if you want to maximise your scamming potential

That is what The Big Short is about.

There are three stories about the euro crisis: the Republican story, the German story, and the truth. -- Paul Krugman

by Migeru (migeru at eurotrib dot com) on Mon Mar 12th, 2012 at 10:01:44 AM EST
[ Parent ]
CDSs on CDOs is just the beginning... You can makes CDOs of those again, and then go on to cubic CDOs..

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Mon Mar 12th, 2012 at 07:47:14 PM EST
[ Parent ]
Sounds like a sequel to Inception.
by rifek on Tue Mar 13th, 2012 at 01:43:14 AM EST
[ Parent ]

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