At the triple-A level, for RMBS that didn't go into CDOs (and a fair part of the stuff that did), the SIVs. The SIVs that were launched in 2006 had much higher proportions of subprime (and recent vintage subprime at that) collateral than the older SIVs, which had a larger stock of better quality but higher yielding assets from before the great spread tightening. Rhinebridge (IKB's SIV) had something like 90% subprime collateral, versus maybe 5%-10% for older SIVs. Cheyne had a similarly high proportion. Naturally, these were the first SIVs to collapse.

Kudos to Yves and the commenters.

To Vinny – leave now before Stroger gets even more of his family into Chicago, and before Daley uses taxpayer money to pay all his cronies in the construction business as they make shoddy Olympics buildings…

"That’s when Eisman finally got it. Here he’d been making these side
bets with Goldman Sachs and Deutsche Bank on the fate of the BBB
tranche without fully understanding why those firms were so eager to
make the bets. Now he saw. There weren’t enough Americans with
shitty credit taking out loans to satisfy investors’ appetite for the end
product. The firms used Eisman’s bet to synthesize more of them.
Here, then, was the difference between fantasy finance and fantasy
football: When a fantasy player drafts Peyton Manning, he doesn’t
create a second Peyton Manning to inflate the league’s stats. But when
Eisman bought a credit-default swap, he enabled Deutsche Bank to
create another bond identical in every respect but one to the original.
The only difference was that there was no actual homebuyer or
borrower. The only assets backing the bonds were the side bets
Eisman and others made with firms like Goldman Sachs. Eisman, in
effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all.
“They weren’t satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn’t
afford,” Eisman says. “They were creating them out of whole cloth. One hundred times over! That’s why the
losses are so much greater than the loans. But that’s when I realized they needed us to keep the machine
running. I was like, This is allowed?”

I think we're a done deal as far as recovery or relevance goes. This is a permanent state of affairs. And it's not just the US, but the entire Western World.

To illustrate, let me use (yet again myself as a case study. As some of you know, I am a shrink extraudinaire, doctor to the stars (except Michael Jackson), and I also teach all sorts of psych classes to the future shrinks of this world (and God knows, they'll be needed).

Anyway, as I have made a name for myself in this racket, I am now receiving teaching job offers in Eastern Europe that actually offer better salaries than what I get right here in the "Leader Nation of the Free World".

SO, Vinny's weighing in his options. But heck, when somebody can earn more in Eastern Europe than in the USA, I'd say there's gonna be trouble… for the USA…

Vinny G. (oh, pardon me, "Dr. Vinny G."

You need to send me your e-mail address, if you don' t mind, since it does not show up on your profile (yves@nakedcapitalism.com) so I can send you that paper.

The TABX is an important detail. I had understood that the illiquiidty had allowed the mark to model fantasy to stand well beyond what should have been its sell-by date, but had thought the creation of the ABX was the trigger.

I hate to continue to be dense, but how did the banks assume the risk? To get the stuff rated AAA (or the various AAA flavors) you needed some type of third party credit enhancement. What did they do to get the agencies to sign off? I get that they retained the super senior (how much would that have been of total deal value? I had thought there were other takers for other AAA paper) but that still does not explain how they got the AAA ratings if the credit enhancement wasn't coming from AIG or the monolines. (I'm assuming if they wrote CDS they would have laid them off. Did they weirdly not hedge the risk on these deals?)

Thanks!

A few things:

1) cash v. synthetic CDOs. treat these interchangeably. believe it or not, the reason for the rise of synthetic CDOs was the voracious appetite for the product. so much so, the mortgage machine couldn't keep pace with the demand for supply. the macro hedge funds who saw the folly of the ponzi scheme were more than happy to line up on the other side of the CDS contracts to buy protection to feed the machine.

2) it amazes me to this day how long it took the conventional wisdom to realize these bonds (i.e., the super seniors, or anything rated AAA for that matter) were not "money good". For the longest time, everyone — from Dick Bove to the Wall Street Journal to the risk officers at the banks themselves — explained this away as a "liquidity problem". No one really got the fact that these things weren't going to return 100 cents on the dollar.

For CDOs, the vehicle of that realization is the height of irony. In every way, it was Wall Street itself that killed its own golden goose with the introduction of TABX. Everyone knows about ABX… not much has been written about TABX. TABX was "tranched" ABX… a product borrowed from the corporate world. Basically, MarkIT took BBB and BBB- tranches of ABX and credit tranched them in much the same way a CDO did. Well, on the first day of trading, the "AAA"-like slice traded down to $60-00. I think that's when people realized there was a problem…

3) You hit the nail on the head when you point out that CDOs were applied to *EVERYTHING*. Banks have generally withstood the hit from ABS CDOs. The writedowns have been taken and most banks are at least partially reserved for the remaining exposure they have to the monolines. But at the same time, the super-senior exposure held by banks off CLOs, CRE CDOs, and TruPs CDOs is still held very much in the context of $100-00. You should read the piece S&P put together re: Assured and their TruPs CDO exposure… its eye opening.

I suppose the jury is still out on whether or not super senior CLOs and TruPs CDOs are money good. If they're not, the world is in for another VERY LARGE round of pain.

3) Yes, it was the monolines and the dumb banks that stood in for AIG once AIG bowed out. But since the monolines are going to get tapped out LONG before they bear the full brunt of their contractual liability, it is really the banks left as the bag holders. Strangely, CDOss were one sector where the traditional bag holders — i.e., the insurance companies — didn't fund the AAA risk. Almost universally they stopped at the first layer of leverage. It was almost as if the CDO was created due to a bottleneck in the ability of the insurance companies to soak up all the volume.

Wow, this is great. My instinct has been that understanding the CDOs is key to understanding the crisis, since they were leverage on leverage vehicles. The risk of everything else pales compared to this. And all sort of assets went into CDOs, which also appears to explain why you saw such tight risk spreads across so many types of credit.

OK, now I did understand even before the business re the equity being very front-loaded.

I still need to unpack this a bit more:

1. You are basically saying the monolines filled most of the gap left by AIG's exit from subprime MBS, correct?

2. Hedgie gets enormous cash flows for a while on equity layer. Buys protection of 2-3X on BBB-tranche (shouldn't someone have had the brains to see what a scam this was? The equity layer being there is phony). Was this 2-3x coverage equal to the value (in some abstract sense, say at an assumed 30% rate of return) on the equity, or were they overhedged.

3. CDS is rolled into another CDO (cash or synthetic?) Is this hedgie rolling the CDS into his own deals, or are these going into other deals?

4. Were the deals in this program only with "real" underlying collateral? If so, who was doing the synthetics? Were they coming out of this and other programs? The reason I am somewhat obsessed with the synthetics is the issuance of them was huge, almost equal to cash CDOs (or so I have read).

I am clearly old fashioned, if the super senior tranches were obviously so awful ex ante (I'm dubious of anything with too many parts, so I am prejudiced, needless to say) the IBs shouldn't have been selling them either.

If you are game, I have a paper from a very obscure firm that figured a fair bit of this out, but I could use some third party input as to where it might be off or incomplete enough to be misleading. If so, please e-mail me. Thanks!

Which brings us to group "A"… For color here, you should read the report put together by the SNB about the drama at UBS. For those into the minutae, it really is a page turner. Some banks, UBS and Citi in particular but also other European monsters, fell in love with the full size of the neg basis potential and convinced themselves paying for the protection wasn't worth the trouble. UBS in fact loved the trade so much they bought the super senior CDO tranches underwritten by *OTHER* investment banks… its competitors. The banks who funded themselves the cheapest were oddly the ones who put this trade on in the most size… truly piggish, but for banks that funded at LIBOR minus, the neg basis portfolios across all assets became a HUGE source of revenue and in a BASEL 2 world, a very efficient AAA one at that.

I hope this helps,