The missing piece to understanding credit default swaps and obligations-- the risk formula used

[LegendKiller]

Originally posted by: Deleted member 4644

I don't understand 100% of what you just wrote, more like 80% but it sounds damn right.

Although, I will agree with conservatives that the lending encouraged by the Dem congress and Clinton did not *help* anything.

If you want me to clarify anything let me know.

What lending encouraged by them? Actual CRA loans? They were relatively low LTV and largely to people who could afford them, I think they were also all conforming mortgages. That means they weren't Option Arms or Liar Loans or NINJAs. They were normal mortgages to normal people who wanted to buy a house and could afford to. By and large they have performed pretty damn well compared to "regular" prime mortgages from any data I have seen.

The idea that CRA caused this is laughable. It didn't even really contribute to it. If CRA contributed anything it might be 1% to the problem, at most.

 

[jman19]

Originally posted by: frostedflakes

Originally posted by: DealMonkey

Originally posted by: Deleted member 4644
http://www.wired.com/techbiz/i..._quant?currentPage=all

Stunning. These banks used the PRICE OF THE CDS (INSURANCE) TO PRICE THE CDOs (ASSET BACKED SECURITIES)!

They assumed the CDS market accurately and efficiently priced in the risk represented in the underlying CDO assets. FUCKING RETARDED.

Stunning indeed. Not only was their formula for determining risk hopelessly flawed, they only fed in data from recent years, when the RE bubble was still growing. No one thought to feed in meaningful historic data and include, oh I don't know, data from down markets?

Wall Street = Epic fail.

The same mistake also brought down Long-Term Capital Management back in the late 90s. Risk models were based on only a handful of years worth of data from a healthy market. Well, uh.. what happens if the market goes sour? Just ignore the possibility and hope it doesn't happen?

Not just that, but they didn't price in the liquidity premium that they would have to place on their positions should they begin to go bust - which, of course, they did.

 

[LegendKiller]

Originally posted by: jman19

Originally posted by: frostedflakes

Originally posted by: DealMonkey

Originally posted by: Deleted member 4644
http://www.wired.com/techbiz/i..._quant?currentPage=all

Stunning. These banks used the PRICE OF THE CDS (INSURANCE) TO PRICE THE CDOs (ASSET BACKED SECURITIES)!

They assumed the CDS market accurately and efficiently priced in the risk represented in the underlying CDO assets. FUCKING RETARDED.

Stunning indeed. Not only was their formula for determining risk hopelessly flawed, they only fed in data from recent years, when the RE bubble was still growing. No one thought to feed in meaningful historic data and include, oh I don't know, data from down markets?

Wall Street = Epic fail.

The same mistake also brought down Long-Term Capital Management back in the late 90s. Risk models were based on only a handful of years worth of data from a healthy market. Well, uh.. what happens if the market goes sour? Just ignore the possibility and hope it doesn't happen?

Not just that, but they didn't price in the liquidity premium that they would have to place on their positions should they begin to go bust - which, of course, they did.

How are you supposed to price in something that is unquantifiable?

 

[LegendKiller]

Originally posted by: chess9
Anyway, ABCP hasn't been ABCP for 10 years! or more. It's more like SAMBCP. (Smoke and Mirrors Backed Commercial Paper.)

-Robert

I wholly disagree. ABCP has been fine until 2004 or so when people shoved anything they could into the market. IT has been a good place for people to fund what was unfundable in the term market.

Right now it's the only securitization market working.

 

[jman19]

Originally posted by: LegendKiller

Originally posted by: jman19

Originally posted by: frostedflakes

Originally posted by: DealMonkey

Originally posted by: Deleted member 4644
http://www.wired.com/techbiz/i..._quant?currentPage=all

Stunning. These banks used the PRICE OF THE CDS (INSURANCE) TO PRICE THE CDOs (ASSET BACKED SECURITIES)!

They assumed the CDS market accurately and efficiently priced in the risk represented in the underlying CDO assets. FUCKING RETARDED.

Stunning indeed. Not only was their formula for determining risk hopelessly flawed, they only fed in data from recent years, when the RE bubble was still growing. No one thought to feed in meaningful historic data and include, oh I don't know, data from down markets?

Wall Street = Epic fail.

The same mistake also brought down Long-Term Capital Management back in the late 90s. Risk models were based on only a handful of years worth of data from a healthy market. Well, uh.. what happens if the market goes sour? Just ignore the possibility and hope it doesn't happen?

Not just that, but they didn't price in the liquidity premium that they would have to place on their positions should they begin to go bust - which, of course, they did.

How are you supposed to price in something that is unquantifiable?

That is true, which is why gauging risk is obviously not a perfect science.

 

[LegendKiller]

Originally posted by: jman19
That is true, which is why gauging risk is obviously not a perfect science.

I would definitely agree with that. The biggest problem, in my mind, was that they obviously weren't pricing in the risk inherent in what they were doing. You had CDO squares being priced at 30bps over LIBOR, which is absolutely stupid. Why? Because they weren't personally liable and they could just hop jobs.

My job is relationship management. I am directly liable to the bank for making sure I perform my job. I have a fiduciary duty to my bank to mitigate risks as much as possible. Since I use my banks balance sheet I have to structure the deals correctly, perform annual renewals, and write extensive credit packages. I have harsh credit officers keeping me honest.

These guys were just buying to buy because they could get it cheap and churn it through. NObody was responsible. It's the same thing with the mortgage brokers.

Personally, anybody who structured CDOs shouldn't have a job in investment management or Wall Street structuring right now. They should be blackballed from ever stepping a foot in front of investors.