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... 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
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