Friday, November 30, 2007

No Bid

With respect to CDOs, naked capitalism describes them as “so arcane, so complex, and so highly differentiated on so many axes that one is likely to need to have a large number of CDOs trading to capture enough permutations to allow for realistic pricing.” For example, “underlying assets (they can contain any tranche of asset backed securities, other CDOs or even CDOs of CDOs, whole loans, mortgages), degree of credit enhancement (whether via overcollateralization or the use of guarantees), leverage, use of synthetics. As a result, the maturity of the deals vary, and the structures used to achieve the desired credit ratings are all over the map.”

In addition, NC says that “you can't get the deal documents.” Here’s his backup for that assertion: In "Where Did the Risk Go? How Misapplied Bond Ratings Cause Mortgage Backed Securities and Collateralized Debt Obligation Market Disruptions," by Joshua Rosner and Joseph Mason (pages 83-4) the authors state that “At present, even financial regulators are hampered by the opacity of over-the-counter CDO and MBS markets, where only “qualified investors” may peruse the deal documents and performance reports. Currently none of the bank regulatory agencies (OCC, Federal Reserve, or FDIC) are deemed “qualified investors.” Even after that designation, however, those regulators must receive permission from each issuer to view their deal performance data and prospectus in order to monitor the sector.”

That is an absurd state of affairs. NC’s logical conclusion is that “if regulators can't get the description of the securities, market participants certainly won't.” No wonder there is little to no bid for these securities. Adding to the confusion is the fact that “many CDOs are "active" or "managed" CDOs, meaning blind pools…That means the investors pony up money before the fund…is formed, and the manager gets to trade it over its three to five year life. No CDO manager is going to disclose his holdings (it would put him at a competitive disadvantage) but how can you value it otherwise?” So many of these CDO’s are essentially opaque mutual funds, not all that different from the garden variety scam where a promoter offers great returns on your money on something like diamond mines in Argentina but you can’t ask what they’re actually doing with your money.

So now that the values of assets making up some CDOs have collapsed, investors want to know what’s in all the other ones they’ve bought into and are discovering how opaque these things really are. So no one wants to buy unless they can see what they’re buying, and if CDO managers aren’t giving in on the disclosure issue no one is going to be making any offers. It would be like buying a used car just from an ad in the newspaper without going to inspect the vehicle at the lot. Now that this has all come to light, situations like the one described at Florida Schools Hit by Fund Freeze are going to appear everywhere. Managers of public funds aren't going to be going anywhere near this type of investment.

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