CDOs

Gretchen Morgenson presents a good Review of the troubles of AIG, but does not fully explore the role of CDOs. They were a mix of low and high Risk Debt which were supposed to make a Profit, no matter if there was some failures in the high risk elements; the entire Context of the CDOs was the expectation that all would pay something towards the overall Debt. They collapsed because the high Risk debt paid nothing when in failure, and low Risk debt had troubles of prompt payment failure under stressed economic conditions. Most of the Debt would still be paid off, but the Insurers had to advance funds to cover expected losses, destroying intermediate term Profitability. The CDOs, like most complicated things, showed (still show) long-term Profitability, though the Costs of doing business in the intermediate term was far higher than estimated. No one existed to cover the Intermediate Costs, as all Insurers operate on planned Investment schedules, where hurried Capital raising from such Products is impossible, except through Sale of the Securities. There was no Market for such Securities, because no Purchaser could handle the Intermediate Costs of the CDOs. This was followed by the inability to split the CDOs, once they had been sold to Investors.

There is much debate about the Moral Hazard of Government bailing out the Investment Banking elements, suggesting the limitation on Risk-Taking will be nullified. It amuses Me, knowing the one factor no one else seems to foresee. Global Slowdown is a Reality, and the U.S. Government is assuming a huge liability, though it should pay off in the Long-Run. I await the Treasury Crisis, where Treasuries find a lack of Purchase. It might not happen this Crisis, because of the long-run Profitability still expected, but there is both a lack of Cash and the question of higher Risk for foreign investors. We have become a World awaiting the dropping of the other Shoe, and the ground is seeming to fall away.

There comes a Time of Complexity, where Insurance becomes an obvious fraudulent attempt to get Investors to cover for the Issuer’s business failures. This forces a decline and avoidance of Credit Swaps. The musical chairs are limited, and the Risk must stop somewhere. It reminds of Roulette, except where the ball stops, stands as the Creature of Loss. It is why CDOs and derivatives of all types are so attractive, because it draws in so many more Players, while the Loss of such Play will descend upon one group of Players. A Fool will insure a Fool, who will insure a Fool, and so on; the Fool becomes a Crook, who doesn’t even understand how he became a Criminal. lgl