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View Diary: Scientists *Prove* Toxic Assets are Impossible to Regulate (268 comments)

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  •  Another possibility (1+ / 0-)
    Recommended by:

    is simply to require that all tapes describing the assets underlying these derivatives are encoded in a standard and machine-readable form.  If you can get all of the information into a database, you can check for yourself on a variety of properties such as the geographic, demographic, and property attributes of each mortgage.  If they are well-distributed, then congratulations, you have a chance of losing your shirt honestly.  If they turn out to all be two-year old 3,000 sq. footers made by a fraudulent builder in Detroit ... good luck.

    But, I think the end message is the same - always require the fundamentals to be as exposed as possible.  That way there is at least the chance to read the fine print.

    •  Sure, but (2+ / 0-)
      Recommended by:
      OdinsEye2k, NCrissieB

      if you are going to force that level of information awareness on potential CDO buyers, then those buyers may as well become direct lenders.  The whole point of a CDO is to be able to extract low-risk investment opportunities that don't require the level of knowledge of risk in the underlying asset that direct lending does.

    •  wrong conclusion (0+ / 0-)

      The issue described here persists even if all information is available, and the root or the issue is how the liabilities and payoffs to different tranches are defined.

      However, I am not sure if the paper describes the "real" problem.  In my opinion, the real problem is the following: well designed derivatives allow to trade "risk" with correct prices if the participants in the market exercise due dilligence.  However, the attention of the participants is diverted from the analysis of the underlying facts (e.g. how long one can keep selling mortgages in markets where buyers cannot afford them without those markets crashing) to the analysis of the model.

      For example, suppose that a car is worth 1000 when it functions and 0 when it does not (so-called lemon) and ca. 20% or cars in a pool of used cars are those that will pretty soon stop functioning.  To sell the cars we issue warranty contracts.  Warranty contracts are pooled and securitized.  Now we have pay someone 250k to provide financial guarantee for  1000 cars -- giving that someone a profit of 50k and removing the risk from our books.  So far so good.

      But suppose that the problem with cars is not that some have hidden defects, but that most of them are insufficiently resistant to corrosion.  More precisely, the problem emerges when salt is applied to roads for to long period of time in a single winter.  Cars survive first and second winter with few defects.  The fee to guarantee 1000 cars drops to 100k.  Then comes a harsh winter and someone who pocketed 100k has 500k liabilities.

      Which would be a "personal problem", except that that "someone" did it 1000 times over, and  most banks gave risk-free loans with cars on warranty as collaterals etc.

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