HEDGEWORLD NEWS

High Hopes (IMF - Tavakoli Warns on CDS and CDO Abuses)

By Christopher Faille, Reporter
August 09, 2005

The IMF is looking at asset securitization, but remains wary of high credit default swap spreads

Janet Tavakoli spoke on "Special Purpose Entities: Uses and Abuses." She referred to the restructuring of Conseco Services LLC, Indianapolis, Ind., in 2000 in order to make a point about the pitfalls for those who wish to make money selling credit protection. People who "weren't actually harmed because the loan was restructured" were demanding payments on the grounds that a credit event had occurred. "One broker called me up and said, ‘we were totally screwed, the banks lied to us' and so forth and ‘nobody warned us that this could occur." She replied, "actually, I think a lot of people did say that this kind of risk could occur … maybe I didn't exactly say it, but I wrote about it, in 1997.

"Even though ISDA says, ‘Gee our language is just fine, we've really cleaned up our act,' … that's not actually true."

Ms. Tavakoli also discussed recovery value. "This is another data issue. What is recovery when a default occurs? Well if you're looking at sovereign debt, your recovery could be very low, if it's unsecured, so we don't have good data when we're pricing the credit derivatives but we do the best we can."

Ms. Tavakoli has the same concern about special purpose entities that Mr. Gregoriou has. She used Enron to make this point. "The issue there wasn't whether or not we knew that the accounting was proper, apparently the accounting was proper, but rather that it mischaracterized the cash flows on Enron's balance sheet. When is a special purpose entity just a clever way of characterizing our cash flows, and when is it a mischaracterization? Well, it's not really clear, and it's really up to regulators to make that call. And it's not an easy call."

Ms. Tavakoli said that the authors of the report over-looked the phenomenon of "language arbitrage." What the examples on which they focus really prove, she said, is simply that "investors should not accept language handed to them as "standard," but should rewrite the contracts to scrub out unfavorable restructuring language and the potential for cheapest-to-deliver issues if they can easily be avoided."

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Janet Tavakoli is the president of Tavakoli Structured Finance, a Chicago-based firm that provides consulting to financial institutions and institutional investors. Ms. Tavakoli has more than 20 years of experience in senior investment banking positions, trading, structuring and marketing structured financial products. She is a former adjunct professor of derivatives at the University of Chicago's Graduate School of Business. She is the author of: Credit Derivatives & Synthetic Structures (John Wiley & Sons, 1998, 2001), Structured Finance & Collateralized Debt Obligations (John Wiley & Sons, 2008).

Janet Tavakoli's book on the global financial meltdown is Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley 2009).

Clients of Tavakoli Structured Finance have the benefit of proprietary consultation, which is not available in any other paid or public forum. Clients also commission proprietary research and analysis.

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