Naturally if buy unfunded insurance, you pay less of a premium

Mar.11, 2008 in Market Outlook

CDOs (Collateralized Debt Obligations) are the problem. CDO’s are repackaged loan, bonds etc, that are cut into slices (tranches). This repackaging of several loan slices is then resold. A CDO is not in itself a derivative, nor is it necessarily sub-prime. However, a higher risk CDO may contain Sub-prime mortgages slices, as well as Credit Default Swap Derviatives (insurance policy).

When Joe Blow defaults on an underlying loans, the problem becomes finding all of the slices of that loan, and distributing that loss to the appropriate CDO (to include calling the default on the Swap).

Because it is complicated, and people didn’t understand the risk, the Investment Bankers were able to work the Subprime loans into the CDOs, and banks kept lending money to people they shouldn’t.

However, none of this (or very little) has to do with Derivatives (the source of the article). CDO’s, a.k.a. repackaged subprime is the problem, not Derivatives.

The orgininal problem did not go away (CDOs), but a new problem (derivatives) is not lurking.

This is only my understanding, garnered by reading and trying to uncover facts, - not by reading inflamatory journalism which can only server to drive consumer sentiment lower.

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