Would it be fair if I say CDO is still a bigger threat to CDS?

It seems that CDS’s net exposure is relatively small (judging from Yves’ comment on Lehman CDS), probably bearable to the underwriters.

Whereas CDO’s structure and the ratings make it the holders quite vulnerable to margin calls as they are not quite hedged??

Thanks.

I think (and I would welcome a correction from wiser heads) that the basic structural problem that hit the residential mortgage securities also affects the synthetic CDOs–it doesn’t take many individual defaults before the top tranches tumble. So if 70 percent of the synthetic CDOs took a hit from Lehman, per the Barclays research, and smaller numbers took hits from the other defaults, then the affected synthetic CDOs have lost some of their ability to absorb future defaults. The individual CDSs may not be a problem (at least not yet), but the structured nature of the CDOs comprised of those CDSs are.

But still trying to understand how worried should I be on this synthetic CDO front. The market itself is only $1.6T and Lehman, Wamu, Islandic banks, etc’s portion of underlying shouldn’t be dominant.

Just curious.

The net exposures on Lehman were indeed surprisingly small. Gross exposures were over $400 billion, net somewhere between $4 and $8 billion.

Yves,
It seems that your comments were relatively benign for the Lehman CDS auction’s impact on the $400B+ Lehman CDS market, but you sound quite worries about its impact on the $1.1T* Synthetic CDO market which only “includes” Lehman CDS?
Would you mind helping me understand this?

I thought October is the month to watch $55T CDS market as series of CDS auctions starts. How come we haven’t heard much about CDS market melting?? And why is it that we are not as worried about $55T CDS market as we are about $2.6T CDO market?

Yes, so far Lehman was the only serious one that went on auction, but isn’t it enough to read across the likely result of WaMu, AIG, MBIA, Merrill, and Ambac?

I would very much appreciate your thoughts.

*I calculated as $1.6T Synthetic CDO market size * 70% of it has Lehman comment from Bloomberg in the post.

Wonder what models/simulation these synthetic instrument authors used to test their products?

does anyone consider that mutli-variate (modified) might make a good first level litmus test?

(Yikes)

Audio link -

http://www-tc.pbs.org/newshour/rss/media/2008/10/21/20081021_solman.mp3

What shocking to me, is that most people (in my MBA graduate school) think this will change soon, well most of them don’t realize what is happening to begin with. They just think its “not good”.