Collateralized Debt Obligations (CDOs) -- those fiendishly complex securities that slice bonds into different groups based on risk -- are a $1.3 trillion pile of toxic waste likely to be written down 90% from financial institutions' (FIs) books. That's a shame because so far FIs have written off $660 billion worth of subprime mortgages and mortgage-backed securities (MBS) and that total is expected to top $2 trillion before it's all over. That is way more than the $340 billion in capital that resides on FIs books.
Since there is very little information about CDOs available, it is difficult to both put a value on them and to know how bad the damage is. One firm estimates that $254 billion of CDOs tied to subprime mortgages have defaulted. But corporate CDOs are privately traded, so the damage from writing down this toxic waste is difficult to quantify. These corporate CDOs were called synthetic -- they consisted of bundles of Credit Default Swaps (CDSs) on corporate bonds.
The $54 trillion CDS market -- famously deregulated by John McCain's chief economic advisor Phil "Americans are Whiners" Gramm -- is now causing shudders for owners of synthetic CDOs since they are tied to the bankruptcy of Lehman Brothers along with Iceland's biggest banks. Fitch downgraded 422 classes of CDOs on October 13 after seven financial companies defaulted or were bailed out since September. And Barclays estimates that 70% of synthetic CDOs were tied to Lehman Brothers.
Why was anyone willing to buy these hunks of toxic waste in the first place? FIs bought CDOs because they offered a 41 basis point (100 basis points equals 1%) yield over similarly rate corporate bonds.
This incredibly complex disaster will cost at least $1 trillion. Was the collapse of the global financial system worth the extra 41 basis points?
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
10-22-2008 @ 11:14AM
BHarrison said...
How can it be that at this point in time, so little is known (been revealed) about the CDSs and the CDOs?
If these are the virtual crux of the $700 BILLION "Bail Out", then why hasn't (and isn't) FULL DISCLOSURE being required and provided. Isn't it a continuation of the fraud against the American people to not require FULL DISCLOSURE as a requirement for receiving ANY "Bail Out" monies?
. . and the BLATANT FRAUD and COVERUP CONTINUES . . . What about the German government's requirements that any coporation receiving "bail out" monies have to:
-- cap corporate management salaries
-- FREEZE all bonuses and other "extra forms of compensations" for management
Why hasn't Congress and the U.S. government implemented these requirements ???
10-22-2008 @ 11:24AM
Brian said...
Hey Cohen, what happened to the CDS disaster you predicted would happen yesterday? Last week you told everyone we were going to have $2 trillion dollar disaster hit our market on Tuesday October 21.
Your predictions continue to be as absurd as your "hack" journalism. You teach management? Your past students must be the ones running the financial institutions....
10-22-2008 @ 11:35AM
BHarrison said...
Yes, as is said "I waited with bated breath" for your projection of there being a disasterous, possibly $400 BILLION payment being required on Tuesday for CITI, JP Morgan, and BAC.
. . . so what happened with all of this???
Why hasn't there been FULL DISCLOSURE about the CDSs & CDOs at this point in time . . . and why isn't that FULL DISCLOSURE an integral requirement for any corporations applying for the $700 BILLION "Bail out" monies?
So the BLATANT CORRUPTION continues . . . and the American people continue to be DEFRAUDED by governement and the financial industry.