one of my favorite finance blogs is written by a vice president at a NY leveraged buyout firm posting anonymously at “going private”. her snarky sarcasm coupled with a friendly familiar tone with the audience make for some genuinely entertaining and educational reading. in any case, she has a post up about the scrappiness going on in credit default swaps and subprime that i had previously written about.
Going even farther, it isn’t the smallest leap in the world to then wonder if a clever bank might not run up rather large default pools, intending from the very beginning to cover the default risk in one of the ways shown above and therefore fixing the default market. Like taking bets on a game you’ve already fixed, in addition to having a large line with another bookie for Federer to lose.
Add to this, the fact that the underlying securities often sit in proprietary portfolios and therefore on the books without markdowns to market, unless there is a catalyst event forcing the issue (and these catalysts are avoided via the loss-shifting described above). This means that it takes a downgrade, for instance (or an exploding hedge fund with angry and vocal equity investors) to force a new “mark to market.” That, in turn, causes a hard look at collateral, margin calls and therefore more marks down to market. Lather. Rinse. Repeat. The question worth asking at this point is “can ratings agencies keep up,” given that they are focused on credit worthiness analysis based on cash flows to the instruments and these are artificially kept high.
read the whole article. i also read this today on the subject of rating agencies lagging on downgrades.
…and more today.
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