The question is: given that the 7:1 ratio is initially correct, and knowing that liquidity has been drying up since February (at the latest; that’s when I noticed it, and I’m not on the front lines), why would you ADD to the LONG position? Isn’t the idea of the trade that the short-term negative carry will be paid for in the end??

(As noted in Yves’s initial post, if the negative carry is a problem, you REDUCE the short position AND the overall exposure–you don’t try to maintain a $14,000,000,000 position if you’re worrying about being short 1/7th of that. At least, not if you don’t want to spend a few hours each day talking with progressively senior members of the Credit Risk Department.)

also, this trade idea is pretty standard, it can be called a “credit curve steepener”. you don’t have to wait for there to be losses to make money, you just need spreads on the lower rated part of the trade to widen out a lot more than the AAA stuff.

Sure, but at that point why not invert the polarity of the deflector shields, redirect the Berthold rays through the Jeffrey’s tube and flood the hedge with nanytes?

I hesitate to mention any texts because they are expensive and may not be what you are looking for. That said, a basic overview book is The Salomon Smith Barney Guide to Mortgage-Backed and Asset-Backed Securities by Lakhbir Hayre. But if you’re not already familiar with basic fixed-income concepts this might be a loser for you. There’s never been an incentive to write a popular guide to complex instruments traded in institutional markets. Maybe there is an incentive now that we’re in the middle of a crisis, but that will probably shade off into human interest anecdotes like popular books on Enron and LTCM. (`It was a quiet foggy morning like so many others in London, when Fred Quantman arrived early to his desk to find that…’) It would be terrific if finance had an expositor like Feynman on QED, but I don’t think finance has any Feymans to begin with.

Of course, we will never know unless other moles at Morgan Stanley come forward, but I wonder if both viewpoints could be correct, i.e, someone put BBB hedge mistakenly on AAA position, someone later looks at what BBB is costing and decides to increase AAA to offset the outlay.

nc jim,

I have been tempted to try to get smarter about sturctured finance. I’ve read a few geeky papers, but the best sources are books (I had found a series, but seem unable to unearth them now). This text looks promising.

Having said that, if you are like me, you probably want to read 25 to 40 pages, not 200-300 pages.

I think the reason no blogger has yet surfaced is some of the ones who are familiar with the terrain like jck are so deep into it that they find it tedious to bring non-experts up to speed. And any proper primer in this area requires lots of charts….

Thanx for the time – I think I get it. I was thinking about a stock short where you borrow and sell shares. This seems more like a put option.

I have a math degree and some quantitative skill but the world of structered finance is not intuitive until it is explained. It would be helpful to discover a blogger like Tanta at CalculatedRisk.com who has authored an “UberNerd” series of tutorials on mortgage finance.

aiming to pocket the credit spread on that tranche to pay the high cost of credit protection on the BBB.

I don’t understand why one would buy protection for a short position. Isn’t the whole idea that the BBB tranche will decline?

I guess I need help with hedging-101.

Sure, SWF’s can act quickly and in most cases their stakes amount to a small percentage of their funds. In the case of CIC further increasing its MS stake, there may be political impediments down the road…or a change in their view of MS. The shareholder issue is on the other side; witness what’s happening with UBS shareholders objecting to the dilutive effects of the recent recapitalization. So far, with MS at least, the dilution hasn’t been reflected in the share price. Odd, but as somebody much smarter than me once said, brains gives you no competitive edge in equities.

Perhaps another aspect of the sale may lie in the fact that should further losses arise, CIC could simply make further injections of capital/increase the stake, after all SWFs tend to have fewer irate shareholders to answer to should they decide to go bargain hunting.