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A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Oct 8th, 2008 at 11:28:36 AM EST
Your point about how the credit funds to companies is the one a little bit weird...and it could turn out to be worrisome other than that I will keep that smile of the picture with this ZP movement :)

A pleasure...

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Wed Oct 8th, 2008 at 01:01:49 PM EST
[ Parent ]
... or unstructured? It is in the structuring and then layering of structured pools of lower ranking streams that CDO's are a very effective vehicle in concentrating systemic risk.

If the CDO's are unstructured, then they simply average both stochastic and systemic risk.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Oct 8th, 2008 at 04:49:22 PM EST
[ Parent ]
I suppose if you took the loan portfolio of a bank or caja and broke it up into groups more or less randomly you'd minimize systemic risk... except for the very small institutions whose portfolios would probably be very concentrated geographically. There are 45 Cajas in Spain, most of them of provincial scope (Spain is broken down in 50 provinces and has 45M people in half a million square kilometres). One of the Cajas has only 20 branches. But I guess the size of the portfolio is correlatd with its diversity.

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Wed Oct 8th, 2008 at 05:06:53 PM EST
[ Parent ]
Why would that minimize systemic risk? Each piece would be on average as exposed to, eg, the risk of an economic downturn driving up foreclosure rates across the board, as any other.

Diversity protects against stochastic risk ... whether it protects against any given systemic risk depends on whether the assets are connected to the same system or systems, and in what way.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Wed Oct 8th, 2008 at 10:00:27 PM EST
[ Parent ]
Explain then what difference does it make whether the CDOs are structured or not - we know the entire pool of loans is connected to the Spanish economy.

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Thu Oct 9th, 2008 at 03:46:07 AM EST
[ Parent ]
Yes, that is the systemic risk exposure.

If you structure a CDO into (for simplicity), five equal tranches, with prepayments to the juniormost tranche, then the juniormost tranche underperforms its 20% of the face value of the income stream by 5 times the default rate. That is normally junk.

So, now take CDO's representing the juniormost tranches of a range of different mortgages pools, form a pool of their income, and divide the income into five tranches.

You diversify against stochastic risks, but if you underestimate the systemic risk of rise in the general default rate, you underestimate how how up the ladder the risk extends.

A 2% default rate leads to 10% underpayment in the juniormost tranche, leading to 50% underpayment in the juniormost tranche in the second tier. A 10% default rate leads to 50% underpayment in the juniormost tranche of the first tier, wiping out the two juniormost tranches of the second tier and the middle tranche pays out at 50% of its total claim.

And of course, if the original under-estimate of systemic risk was used to size the tranches to get the maximum number of CDO's of investment grade, you've basically locked in a guarantee that the "investment grade" assets in the second tier will under-perform their rating, since optimizing means putting the boundary as close as possible to what is considered an acceptable risk.

Senior tranches in the first tier of a pool with genuinely decent quality mortgages are not the worry ... its when layers are used in cahoots with information on exactly what risk profile is needed to get an investment grade rating, and/or when the underlying pool is junk (when structuring is used to paint a pile of chickenshit white and call it a basket of eggs), that the multiplication of systemic risk really kicks in.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Oct 9th, 2008 at 07:07:32 AM EST
[ Parent ]
The risk will be now on the government.. so far is clear... but I do not get why the risk for the government will change depending on how present credits are reorganized...

It is more like which credits will be passed on than how they will be passed.

That's the key about the government risk... will they take a normal sample or will they concentrated ont he ones which may gone burst more easily in case of meltdown?

Or is the structured and unstructured difference key for knowing which credit/debt the government will take?

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Thu Oct 9th, 2008 at 04:00:48 AM EST
[ Parent ]
... its a lemons problem. Banks have an incentive to use the assets with the worst likely future performance that they can get away with, so they hold onto the best income potential of their current balance sheet.

So its up to the government to ensure that the minimum accepted quality is an acceptable quality.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Oct 9th, 2008 at 07:12:22 AM EST
[ Parent ]
Absolutely... and this can happen indeed with the credit to small and meidum companies.. not so much with mortgages which are all quite the same in Spain...

Mortgages are purely random shots, except for some very few cases that a bank could detect (some pre-clusters in the last month data).. but it is doubtful...

on the other hand.. on companies.. yes indeed.. it is about how much shit or no-shit is the government ready to accept and how much time they spend looking at it.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Thu Oct 9th, 2008 at 04:49:46 PM EST
[ Parent ]
... structure on the pool of mortgages. If there is a certain rate of default, that falls on the most junior tranche first ... no matter which mortgage in the pool was defaulting.

If it is actual pools of performing mortgages being used, and a new unstructured CDO is issued on top of that, that spreads the risk within the pool evenly across each CDO. If bought at a suitable discount, they'd be no worse than holding a diversified pool of mortgages directly (how bad that is will vary, from country to country, based on how much financial fragility entered into the home mortgage business).

If existing CDO's are being used, Senior tranches in the first tier, with the collateral being the pool of mortgages themselves, and with the mortgages being prime mortgages with very little funny business, they are sheltered by the derivative structure from risk, and with due diligence it seems plausible to treat them as quality assets.

As the structuring becomes more complex, it becomes more urgent to dig into the details to determine whether systemic risks are being concentrated ... and indeed, it may make sense to simply rule out using second tier or higher CDO's at all.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Thu Oct 9th, 2008 at 05:09:00 PM EST
[ Parent ]
I sincerely hope they are not proposing to buy CDO2.

As Pierre has warned repeatedly, apparently Spanish institutions did a round of securitization last year for the sole purpose of taking advantage of the ECB's repo facility. I would hope that the need to make and rate them in haste would imply that they are relatively simple in structure. If what is happening is that the ECB is selling them back to the banks and the Spanish Treasury will buy them, we might be okay.

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith

by Migeru (migeru at eurotrib dot com) on Fri Oct 10th, 2008 at 03:52:35 AM EST
[ Parent ]
that's a very interesting point.

Indeed , spanish banks could have prioritize mortgage structures in their balance sheet... but accordign to the sorces I read, everybody says that they do nto have them...in large amounts...The name behind it is "cedulas hipotecarias", and it has never been clear how the bank pays its clients the Euroibor interest rates (guaranteeed) from the mortgages

So , if there is a small amount of these kind of 5% default you lose everything  tranches I hope the bank takes it as a loss, pays the cedual hipotecaria and keeps on running.. because it has enough money...

My idea abut what the governmet was going to do is a) take most of the not structured mortgages (those which are in a general pool) and then take up until a certain risk in the structured so that the bank knows exactly the maximum loss.

I guess it will be known in cognress if this is the case, on the other hand, my doubt has always been how do you deal with private companies debt which are not structured...they have to make the structure on purpose and take the risk out of the bank. Basically, the government is going to do what the financer where doing plus takign the risk.. the government will structure the debt and the credit lines and buy it.. since it is not clear how it will be done, it is the nly part that I may not like.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Oct 10th, 2008 at 05:49:47 AM EST
[ Parent ]
It will depend heavily on the regulatory history ... the US exposure is due to the Fed and state regulators seeing these assets on balance sheets of institutions in place where investment grade assets belong and never saying, "sorry, we don't care what the rating company says, these are not real investment grade assets. Clean up your book."

One reason that Australian banks are not first in line in this banking panic ... though they certainly are losing quite big chunks of shareholder equity right now ... is that the Australian regulator has been working on cleaning up balance sheets basically since the US bubble burst, while the Fed was looking for ever more ways to provide liquidity until "the return of normalcy". Obviously that was aided by the fact that Oz was still in a commodity boom at the time ... its easier to clean up balance sheets when there is new business coming in.

Also, if the total share of structured derivatives in the flow of mortgage creation was relatively small, then there would be much less pressure to create second or deeper layers ... and if the total number of mortgage pools issuing investment-rated and junk-rated tranches are smaller, on the one hand its harder to put together a diversified mix of junk CDO's from different pools, and on the other hand there's less pressure to do so, since there's less problem of overwhelming the market for the speculative junk offering the high returns.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 10:50:05 AM EST
[ Parent ]
If I am not mistaken the Bank of Spain disallowed off-balance-sheet 'conduits' and SIVs years ago.

A vivid image of what should exist acts as a surrogate for reality. Pursuit of the image then prevents pursuit of the reality -- John K. Galbraith
by Migeru (migeru at eurotrib dot com) on Fri Oct 10th, 2008 at 10:52:54 AM EST
[ Parent ]
I don't know the details of prudential regulation in Spain, I assume that the Bank of Spain is the sole/lead prudential regulator for the banking system.

Of course, in the US, with an undersized banking sector and oversized capital markets, just doing that for banks would not have sheltered the US from the current Panic, but it still would have reduced the exposure for banks as such.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 11:01:10 AM EST
[ Parent ]
For the Structured Investment Vehicle and its acronym, SIV, any idea of which originally came first to the mind of their originator?

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Oct 10th, 2008 at 11:10:44 AM EST
[ Parent ]
... structured investment vehicles were invented first, and then the generic term created after as a way to talk about them in general.

But the term itself ... my, goodness, what a solid sounding thing. "Structure" ... who can be against structure? You want a chaotic vehicle instead? And "Investment" ... much, much better than speculation.

In choosing between "Ramshackle System-Risk Amplifying Vehicle (RSRAV)" and "Structured Investment Vehicle (SIV)", the second sounds much, much better.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 12:07:42 PM EST
[ Parent ]
Funny how value seems to leak out of them like water from a sieve.  I wondered if they had been invented by some Enron type jokester who first conceived of a seive like structure from which he could benefit and yucked it up.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Oct 10th, 2008 at 12:18:42 PM EST
[ Parent ]
No, Enron did not invent much of anything except a corporate culture of financial gimmickry to try to get something for nothing ... off the balance sheet transactions, structured investment vehicles ... the hard part is either getting a regulator to sign off on it or getting some pollie to take the regulator out of the game.

And of course that invention was only a re-invention of something invented countless times before.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 01:18:39 PM EST
[ Parent ]
It is in spanish.. but here is an excelletn link.. and an explanation of why the mortgage buy is generally a good idea and will shield the spanish economy...

http://www.soitu.es/soitu/2008/10/09/actualidad/1223568245_318730.html

I do not know if you read spanish.. I hope... it basically says tat cedulas are not SIV (they were forbidden) nor CDS nor CDO... they were bonds given by the bank insttuion to pay with the guaratee of the insitution, the mortgage and the building (whcih  belogns to the bank if its nt paid) plus the 20-30% amount of direct cash payment.

If there is a massive mortgage default, banks will have to deleverage by caliming debt or selling houses, to pay for the interest rates to te costumers that bought it... so if there is a meltdown they could end up having to sell hundreds of houses to pay and rebuy the cedulas... that would be crazy during a recesion.

With this buy, the government will take a risk up to a certain level.. if defaults are contained the treasury will earn a lot of money if there is a meltdown, the banks will have no meltdown and teh treasury willr aise debt 4 pints over the GDP.

Another completely different issue are the private comapanie debt that banks have now...

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Oct 10th, 2008 at 12:58:59 PM EST
[ Parent ]
... mortgage market of the 50's and 60's, especially the cap on mortgages at 80% of property value.

And, no, I do not read Spanish well enough to read that in the original, but I read Spanish well enough to follow it in the Babelfish translation.

The systemic risk is that broad-based default of the mortgages would lead to solvency problems at the institutions that guarantees the bond. The difference between an unstructured CDO on the same pool of mortgages is that with an instructured CDO, the holders would pay for the haircut if there was a spike in foreclosures, while with the mortgage-bonds, its the bank pays for the haircut.

And, no, there is none of the concentration of systemic risks that comes with structured CDO's.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 01:41:47 PM EST
[ Parent ]
Exactly... this is why I did nto see that a big problem ont he mrotgage problem.. it is a tailor-amde solution for Spain...

but as you I ahve said pre cisely, the bank debt and credit on companies can look very much a structured vehicle created and bought byt the treasury...

so your point about asking for guarantees in equities makes a lot of sense.

A pleasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Oct 10th, 2008 at 04:13:40 PM EST
[ Parent ]
... this is why I suggest that €1:€1, the acquisition of assets be matched by the issue of Senior Preferred shares, at a penalty dividend rate over the rate of the government bonds funding the acquisition, with heavy strings attached to non-performing Preferred dividends, and with warrants for further Senior Preferred shares on the net loss on the acquired assets.

That provides liquidity, and shifts the balance sheet from debt to equity making the bank a better risk for lending to, and takes the warehousing of sine if the dubious assets off the banking sector's balance sheet where it can easily act as a drag on credit for quite a long time.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Fri Oct 10th, 2008 at 10:57:36 AM EST
[ Parent ]
It seems a good idea...

specially on the actives related with private debt.

A leasure

I therefore claim to show, not how men think in myths, but how myths operate in men's minds without their being aware of the fact. Levi-Strauss, Claude

by kcurie on Fri Oct 10th, 2008 at 01:00:19 PM EST
[ Parent ]

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