Synthetic CDOs Are Coming

They are back from the dead and marching south.
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By Klapi (Own work) [CC BY-SA 4.0], via Wikimedia Commons

By Klapi (Own work) [CC BY-SA 4.0], via Wikimedia Commons

Some years ago, an army of synthetic collateralized debt obligations almost killed the economy. But King of the Fed Ben Bernanke stopped them with a bigger army of freshly-printed dollars, and then Sers Dodd and Frank went on crusade and had killed almost all of them by 2014. But then one of the survivors, shivering and cold and forgotten, captured a banker and pumped him full of need to create yield. And now an army of White Walker CDOs are once again threatening the peace and security of the global economy.

In Europe, the total size of market is now rising again—up 5.6% annually in the first quarter of the year and 14.4% in the last quarter of 2016, according to the Securities Industry and Financial Markets Association….

Desperate for something that pays better than basic government bonds, insurance companies, asset managers and high-net worth investors are scooping up investments like synthetic CDOs, bankers say, which had largely become the preserve of hedge funds after 2008.

Luckily, Sers Dodd and Frank erected an enormous wall of capital requirements designed to prevent such an army from once again menacing the financial system.

Synthetic CDOs have evolved since the crisis, bankers say. For instance, most are shorter-dated, running up to around two to three years rather than seven to 10 years. Some banks will only slice and dice standardized CDS indexes that trade frequently in the market rather than craft tailored baskets of credits….

Postcrisis regulations have forced banks to set aside more capital against these transactions and use less leverage. That has encouraged banks to parcel out the risk to clients rather than keeping it on their own books.

Thank goodness for that wall, right? And it’s dogged defenders. It sure is a good thing that no one south of it is doing anything that might undermine its effectiveness.

In a Blast From a Financial Crisis Past, Synthetic CDOs Are Back [WSJ]

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