Distraction from destruction?
Sir, in the Global Financial Stability Report prepared by the International Monetary Fund (IMF) for their meetings in April in Washington we can read (Box1.1, page 8) that “$220 billion of the outstanding stock of subprime mortgages and second-lien loans packaged into asset-backed securities (ABS) in 2006 was comprised of noninvestment-grade tranches, most of which were repackaged into collateralized debt obligations, CDOs . . . [with] about $175 billion of senior tranches, $40 billion of mezzanine tranches, and only $5 billion of equity tranches”. Since the previous quote reads so eerily close to a technical description of what could be a financial weapon of mass destruction, it is really hard to fathom how little attention it received, even recognizing the distractions.
From my perspective, although some will look to camouflage these problems and their roles in creating them with arguments such as a weakening conditions in the housing market, there can be no doubt that the market for these investments were in fact exposed to too generous credit ratings. I have no clue about the quality of the $ 40 billion in mezzanines, but to think that only $5 billion in equity tranches could serve as a reasonable shock absorber for the risks in the remaining $215 billion of paper is almost laughable, since we all know that the protective worth of those $5 billion has probably all been readily consumed by all the expenses and success fees generated in order to put in place the deals and market the paper. In an almost humorous note, the IMF worries about the worth of these $5 billion of equity tranches, while of course what they need to worry about is the remaining $215 billion, wherever they can be.
Therefore, one of the main problems that should have been analyzed more in depth during the spring meetings was the possibility that having awarded so much power to some few credit rating agencies in determining the capital flows in the world, might have set it up to some very dangerous financial systemic risks, and then of course on what to do about it.
From my perspective, although some will look to camouflage these problems and their roles in creating them with arguments such as a weakening conditions in the housing market, there can be no doubt that the market for these investments were in fact exposed to too generous credit ratings. I have no clue about the quality of the $ 40 billion in mezzanines, but to think that only $5 billion in equity tranches could serve as a reasonable shock absorber for the risks in the remaining $215 billion of paper is almost laughable, since we all know that the protective worth of those $5 billion has probably all been readily consumed by all the expenses and success fees generated in order to put in place the deals and market the paper. In an almost humorous note, the IMF worries about the worth of these $5 billion of equity tranches, while of course what they need to worry about is the remaining $215 billion, wherever they can be.
Therefore, one of the main problems that should have been analyzed more in depth during the spring meetings was the possibility that having awarded so much power to some few credit rating agencies in determining the capital flows in the world, might have set it up to some very dangerous financial systemic risks, and then of course on what to do about it.
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