Thursday, July 12, 2007

This Could Be Fun: A Third Post I Don't Have to Write

by Ken Houghton

Felix Salmon gives a briefing of how difficult it would be to show collusion in CDOworld. Select excerpts:
Firstly, the big banks are not generally big holders of CDO tranches. The whole reason why CDOs exist in the first place is that they're a mechanism for moving risk off the balance sheets of the sell side, and onto the balance sheets of the buy side.

English translation: Your pension fund is SNAFU.
Part of the reason is that they don't need to collude in order to hold on to their CDOs. CDOs, by their very nature, are a buy-and-hold investment. There's almost no liquidity in them, and the explicit tradeoff in the CDO market is that investors get a higher coupon by giving up liquidity.

The perversity of it is that in a vibrant market, you shouldn't have to buy a CDO. But that's another post.
You can't short something which never trades, and as far as I know no one is writing credit protection on CDOs. There are lots of people writing credit protection on MBSs, including subprime-backed MBSs, but they're a different instrument entirely.

This is why, all those posts ago, I compared this "meltdown" to the Structured Note market. I tried at one point to go short a Structured Note (don't ask) and cover it in the Repo market. After almost a full day, no one could find it. As with CDOs, the assumption is that you will Hold to Maturity. You bought it, you own it—even if it breaks.

And, most preciously:
One option is to address the general topic without quoting my question [presumably the post's title, "Why There Aren't Anti-Collusion Lawsuits in the CDO Mess," in question form) and without mentioning magic words like "antitrust" and "collusion."

Frankly, I'm not clever enough to answer this question without quoting it and without using the magic words.

It's arguably not collusion when everyone, working in their own self interest, does the same thing—just as it wasn't collusion when they bought the paper in the first place. And the glut of hedge funds created in recent years makes it fairly clear that a "barriers to entry" argument will fly about as well as, say, Amaranth did late last year.

If I were thinking lawsuit, I'd be using terms such as "fiduciary responsibility" and "prudent" and looking at mutual fund investments in hedge funds: low-hanging fruit may not be the tastiest, but it is the most accessible.

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