Economy
Related: About this forumWSJ: One of Wall Street's Riskiest Bets Returns (synthetic CDOs)
Here we go again...
http://online.wsj.com/article/SB10001424127887324423904578525701936124838.html
In a sign of how hard Wall Street is trying to satisfy voracious demand for higher returns amid rock-bottom interest rates, J.P. Morgan Chase JPM -0.83% & Co. and Morgan Stanley MS -0.71% bankers in London are moving to assemble so-called synthetic collateralized debt obligations.
CDOs give investors a chance to bet on the creditworthiness of a basket of companies. Basic CDOs pool bonds and offer investors a slice of the pool. Synthetic CDOs pool, instead of the bonds themselves, insurance-like derivative contracts on the bonds.
Like their crisis-era predecessors, the new CDOs would be sliced up into different levels of risk and returns. Investors who want a chance at the highest returns would have to buy the riskiest slice.
While spreading risk in some ways, synthetic CDOs also can multiply the financial damage if companies fall behind on their debt payments.
marmar
(77,106 posts)nt
dixiegrrrrl
(60,010 posts)A more complicated way of describing insane behavior.
longship
(40,416 posts)Then get the rating agency to rate it AAA.
But a synthetic CDO is comprised not of mortgages, but of credit default swaps on mortgages which is an insurance policy against the default of the mortgage. It replicates the mortgages in risk, though. If the mortgages go bad, the credit default swap pays off.
These things are risky because when a bunch of mortgages go bad, all the swaps go bad at the same time. This is how AIG went down. Their exposure to swaps was huge. That alone almost brought down the world's economy in 2008.
Read about it in Michael Lewis's great book, The Big Short. Highly recommended.