Wall
Street – Exotic Debt May Pose Risk for Investment
Banks
By
Dan Wilchins
NEW YORK,
Aug 18, 2005 - (Reuters)
The face value of outstanding CDOs, including derivatives known as synthetic
CDOs, could top $2 trillion [in equivalent notional amount], according to CDO
consultant Janet
Tavakoli, though
estimates of the market's size vary. A decade ago, that figure was closer to
$2.46 billion.
One way that CDOs may threaten banks' and brokers' earnings is from CDOs held
on their books, experts said.
In CDOs, some investors usually agree to be the first to take losses if credits
in the portfolios default, in exchange for receiving a higher return. Other
investors agree to be the second to take losses, in exchange for lower returns,
and so on.
But selling all the pieces, or tranches, of a deal can be difficult, leading
dealers and banks in some cases to sell just single tranches and retain the
rest of the risk.
In recent years, dealers have begun selling tranches to investors that are
supported by a portfolio of credit derivatives, and hold the rest of the risk
on their books. They attempt to hedge that risk as the market changes.
The dealer's exposure appears limited to a single tranche, but if market conditions
change, dealers have to adjust their hedges. They could find that they have
more risk and lower returns than they would have had if they had sold every
tranche, Tavakoli said. That could create large losses, she
added.
END OF EXCERPT
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.
TSF makes some information available to the general public. Please
click here for other articles.
|
