Goldman and Barclays are out touting old structured credit technology, apparently collateralized debt obligations, and claim they have been tamed and repurposed and are now virtuous.
I am skeptical of these assertions, and welcome informed reader comment. CDOs in particular were leverage on leverage vehicles, and indeed, that seems again to be the reason for turning to a variant on that theme again, to minimize equity requirements.
The amusing bit is these news structures are argued to be “transparent.” If you buy that, I have a bridge I’d like to sell you.
If you have a dog’s breakfast of assets, some of them tranches from other deals, and then you tranche that, what good does transparency do? It’s a complicated mess to analyze. Opening the hood does not make it any more comprehensible to anyone other than an industry expert equipped with specialiazed software and access to sources that help him come up with default and loss probabilities. Most investors and all regulators will find them impenetrable. Which is precisely the point. I wonder if the assertion of transparency is Emperor’s new clothes in action, designed to cow those who can’t fully grasp the workings of these vehicles.
But the cheery sales talk is just breathtaking. You’d think it was spring 2007 all over again. Maybe that’s the objective.
From the Financial Times:
Investment banks, including Goldman Sachs and Barclays Capital, are inventing schemes to reduce the capital cost of risky assets on banks’ balance sheets, in the latest sign that financial market innovation is far from dead.
The schemes, which Goldman insiders refer to as “insurance” and BarCap calls “smart securitisation”, use different mechanisms to achieve the same goal: cutting capital costs by up to half in some cases, at the same time as regulators are threatening to force banks to increase their capital requirements.
Yves here. You gotta love the attempt at rebranding established technology. Back to the story:
BarCap’s structures involve the pooling of assets from several clients into a secured financial product that can be sold on to other investors and rated by a credit rating agency, potentially reducing the capital allocated against the assets by between 10 per cent and 50 per cent.
These new mechanisms are in some respects similar to the discredited structured products, which were widely blamed for fuelling the financial crisis. But the schemes’ backers argue there are two significant differences. First, they involve the securitisation of banks’ existing assets, rather than of new lending. Second, bankers argue that the new products do not disguise the transfer of risk….
However, some regulators may be wary of the invention of new pooled asset derivatives, especially if they are perceived as a way to avoid regulatory capital requirements.
Some rival bankers also view the schemes with scepticism. “This is a system of capital arbitrage,” said one senior banker at another investment bank. “The need for capital just miraculously disappears.”
BarCap has worked on portfolios worth hundreds of billions of pounds in recent months, including those of the Barclays’ parent company. Investors in the securitised products typically include the original banks, plus third parties, such as hedge funds and private equity firms, as well as BarCap itself.
Separately, Goldman is working on what bankers said was a private-sector version of the UK government’s asset protection scheme. The goal would be similar – to reduce the capital that would need to be held against the assets – although Goldman has yet to find a balance between the risks and rewards that would be attractive to investors.
Yves here. That is code for “Goldman is spinning its wheels.” I’m surprised they’d noise this up with the media if they hadn’t come up with a viable solution. Hhm, are we back to the MLEC problem, which no one can ever solve, that no matter how much lipstick you put on these pigs, there is an unsolvable price gap between what bank owners of the paper are willing to sell it for and what buyers are willing to pay? Back to the story:
Investment banks do not believe they can compete with the government-sponsored APS, mainly due to scale. RBS and Lloyds between them are putting £560bn ($914bn) into the scheme. Under Goldman’s idea, it would sell an insurance product to a bank with a toxic portfolio, effectively shifting the risk of the underlying assets off the balance sheet. The insurance would require far less capital to be carried against it than the original assets.
Deutsche Bank engineered a comparable structure to facilitate the dismantling of risk at failed insurer AIG, although bankers close to that transaction said without government involvement the cost of such a structure would be commercially unfeasible.
The Lex column adds:
Those clever investment bankers are at it again. It was surely only a matter of time before banks tried to apply their financial innovation skills to finding ways of profiting from the very crisis that misuse of those skills brought about…
On one level, such initiatives might be welcomed as industry practitioners try to find a market solution to their own problems, reducing the need for taxpayer-funded bail-outs. But there are dangers here. As studies of the origins of the financial crisis such as the UK’s Turner Review have concluded, one of the keys to creating a sounder banking system is increasing the quantity and quality of bank capital – which also, of course, means lower returns. Since the new schemes being developed are designed to cut the capital cost of risky assets, they potentially go against the spirit of such proposals.
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I don't know the details of these specific schemes, but there are a lot of similar restructuring programmes about. Many of the investment banking boutiques that have been set up recently are trying to do this sort of thing. Typically it involves getting a third party (or a joint venture with a third party) to put up some equity for the portfolio, while the bank holds the senior paper. Depending on the assets and the bank's preferences, it can be done synthetically or on a true sale basis.
The dreaded re-REMICS
http://www.bloomberg.com/apps/news?pid=20601009&sid=a0TGMrBy2PyE
A more recent FT article (Bloomie was *last* July)
http://ftalphaville.ft.com/blog/2009/06/19/58146/re-mimicking-the-crisis/
Re-remics aren't really about capital, though. They're about TALF eligibility – which means senior funding. You could conceivably save some capital with re-remics, but not a lot.
It's true, they are transparent. I looked, and it's the same crap that caused the first crisis.
They should feed their old stuff to prisoners.
Ginger,
I see what you mean. The story talks about sales to investors, so my first impression that it was just another iteration of credit enhancement can't be anywhere near right. It would be nice if they gave an example.
What on earth can the structures be? They can't be outright sales to investors (that would eliminate the capital requirement, not reduce it). Some mix of CDO repackaging, sale and off-balance-sheet vehicle? Something like that Merrill firesale of ABS last year, wherein the buyer had a put option on the assets?
GS "insurance" sale: I wonder if they are acting as agent or principal…
The real issue will be what the final rating and duration on the top-level tranches will be. CDOs and SIVs were able to get away with repackaging toxic waste because the ratings agencies were happy to slap AAA on securities which barely deserved B.
If these securities get a high enough rating and have sufficiently short duration, we could go right back to where we were a few years ago, with big funds (especially money market funds) buying them on autopilot. Of course, that would not resolve the issue of the middle-rated tranches, which will be difficult to place, but still, it's a cause for concern.
Goldman's idea sounds a bit like a negative basis trade. Buy CDS-type protection for the underlying, book the difference between the cost of the CDS and the income stream to earnings. Maybe in this case, the cost of the insurance goldman is selling exceeds the income stream so they're booking a loss but at least the capital cost for the bank holding the dud asset is minimized, without having to sell at a firesale price. Maybe not actually an entirely bad idea, but it basically amounts to healthy institutions leveraging a strong capital position which could be significantly weakened if the premiums charged weren't sufficient for the risks taken on. Instead of the PPIP, the gov could sell insurance for assets still on bank balance sheets, reduce capital charges against them to allow for new lending and see some upside in the form of premiums paid if the asset eventually recovered. How's that for a subsidy the taxpayer wouldn't understand. Timmy?
Richard, like I say, I don't know the details of these particular schemes, beyond what was reported in the FT, but when I've heard of similar schemes, it's usually involved getting a third party to take a first or second loss position in the portfolio, while the originator kept the rest of the exposure (which might consist of a rated trance). The capital reduction for the originator would depend mainly on how much of the expected loss remained with them. The FT's piece makes it sound like Barclays is doing something like this, possibly through joint ventures (so, possibly, the bank and the third party jointly set up a fund/company that makes the equity investment).
I could be totally wrong, but that's how it's been done by other firms.
In some cases, the reremic makes sense. If you hold a once AAA now BB asset and can get some rating agency to claim that some portion is money good, why not benefit from the unexpected new regulatory capital? But many of these transactions make no economic sense … buying up AAA bonds as collateral to reremic into "really good" AAAs and "so so" AAAs is blatantly stupid if AAA has any meaning (these transactions are saying that AAA probably doesnt mean anything anymore).
This only works if the ratings agencies play along again. "although Goldman has yet to find a balance between the risks and rewards that would be attractive to investors" means they havent beaten the agencies up enough on how much of the cap structure will be rated AAA. Less reg capital means better looking ratios equals higher stock price. Govt is happy to look the other way and can blame the agencies (no new regs yet on these guys) if anything goes wrong.
Why you guys trying to figure this out? It's the same scam.
How can you achieve lower capital reserving without shifting risk? If you don't shift the risk, you are simply cutting the reserving buffer. OK, let's allow it to stand for a minute. According to the BarCap guy it's not for the purposes of arbitrage or leverage. But reducing the capital reserving is increasing the leverage. And it is also an arbitrage play against the reserve requirements. I'm just amazed at this Orwellian double speak.
If you let Spivs run banks, then expect to be fleeced.
I'd rather buy a refurbished laptop than a repurposed CDO .
Nail is on the head, "most investors and all regulators will find [these so-called transparent CDO's that they are calling insurance schemes or smart securitization] impenetrable" and incomprehensible.
I love the rationals bankers provide for this maneuver, one, they are not trying to peddle/recycle new toxic waste only the old waste, and its okay because they are now being upfront about the transfer of risk whereas before they well, well they must have been disguising the transfer of risk with the old products, which in turn means by admission they were indeed peddling pigs in a poke to the unsophisticated investors or to those investors to trusting to be bothered with something called DD
Under Goldman's idea, this so-called insurance product sounds eerily like a credit default swap by another name. So, now Goldman and BarCap are acting as the next AIG's?
And I wonder how goldman will wall off these new insurance risks to the firm, as and when it comes to that. How will they have their asses covered and ours the taxpayers exposed?
Yes, Yves, I am still lurking, its kind of nice to drop in a comment again
YS:
I read this article. Did I miss something or are these CDOs with a new coat of paint?
i wonder if Goldman's "insurance idea" to wrap the assets is the Derivative Product Company similar to Primus, Athilon?? They were developing it in the past but I think shelved it. DPCs make more sense today compared with SIVs, as they are "continuous capital", vs. SIV model, where they had to roll it every month. DPCs, OTH, are "bankruptcy remote" and get funded at day one. high rating gives let leverage, although not sure what kind of leverage they can achieve today, maybe 10:1 max. These programs were in development at many IBs, but not sure if they work anymore. Although, IMO they make a lot of sense, since the need to "shift risk" and "free-up" capital is huge. Anybody has thoughts?? TIA.
Let me play the rube with a dollar burning a hole in my pocket. I suppose that at some point, or moment, I am supposed to fork over the dollar for some of this. Is this the kind of paper for and about which a proposed Consumer Protection Financial Investment Jackboot on the Neck of Free Marketeerism is to stand?
Dreck by any other name is still dreck. I'm trying to figure out who would buy this stuff, seeing everything that has happened, without totally and absolutely abrogating their fiduciary responsibilities. I mean "we bought more funny paper to cover this other funny paper" just doesn't seem to cut it as a defense anymore.
I can see Barclays and Goldman hawking this stuff and looking to make money on the fees but this is still pushing the risk and the losses around. Those have to go somewhere but as others have noted the goal of all these schemes is to stick the taxpayer as the ultimate patsy and I don't see how they are going to do that. Sucker the pension funds into this? And when they go bust, dump the losses on the taxpayer that way?
DPCs were pretty much killed by Lehman. With everyone worried about counterparty risk, nobody was willing to accept their CDS any more, even though most of their exposure was corporate and sovereign. I think they're all pretty much in run-off, although they should have enough capital to pay off their liabilities.