June 2007: 10 Questions About CDOs

Here is a blast from the past: Precisely 4 years ago on June 30th, we took a closer look  at CDOs. It was in response to a remarkably sanguine question: CDOs: what’s the big deal?

We thought they were a big deal, and posed 10 Questions About CDOs.

Here are my 10 questions:

1. What would have happened had Bear Stearns simply let their two funds, High-Grade Structured Credit Strategies Fund and High-Grade Structured Credit Strategies Enhanced Leverage Fund, dissolve?

2. If CDOs are not priced to market, what are the actual values of these holdings?

3. How levered up are the funds that own the bulk of the CDOs? 10-to-1? 20-to-1? More?

4. How many Hedge funds are or have been taking quarterly or annual performance profits, based in whole or in part, on hoildings that have been marked to a theoretical value (“Mark-to-Model”) versus an actual value (“Mark-to-Market”)?

5. Liquidity has been a driving force behind M&A activity, share buybacks, and leveraged buyouts. Might the CDO situation somehow impact liquidity?

6. Might a liquidation in a CDO/illiquid derivative fund spread to other asset classes?

7. How widely held are the toxic CDO tranches in funds that are self-decribed as “conservative” or “risk averse?”

8. How accurate are the major ratings firms (Moodys, Standard & Poors, Fitch) assessment
of these products. Are these outfits arm’s length objective raters, or
are they merely corporate whores who play for pay?

9. After the final chapter is written on CDOs, what might the total losses on the $250 Billion in quarterly CDOs that Wall Street has created actually be? 10 Billion? 100 Billion? 1 Trillion?

10. How much will systemic confidence be impacted if there is a
series of large fund failures due to CDOs? What impact might that have on the rest of the markets?

The point being: All that was required to recognize the brewing trouble was a willingness to ask questions, ignore traditional assumptions, question authority, and challenge what the “experts” were saying.

What trouble might be brewing now . . . ?

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