Thursday, October 8, 2009

Speaking of re-regulation: John Thain and CDOs-squared

Continuing with the theme of the immediately preceding post - what brought us into this economic state ...
I will admit: apart from a guess based on threshold derivative knowledge of what a collateralized debt obligation ("CDO") is, I have no functioning knowledge of what a "CDO[s]-squared" is. But former Merrill CEO John Thain does, and he had some things to say about it earlier this week.

These instruments were so complicated. One of these — I’m talking now about ABS CDOs, and actually the CDOs-squared are even worse. Merrill created one. I picked one particular one. To actually model out the things that are inside an ABS CDO [is difficult] because derivatives are already inside the CDOs. They’re already derivatives created out of derivatives. So you have to go way underneath to get to the actual pools of mortgages. To model correctly one traunch [sic] of one CDO took about three hours on one of the fastest computers in the United States. There is no chance that pretty much anybody understood what they were doing with these securities.

Creating things that you don’t understand — that the buyer doesn’t understand, that the rating agency doesn’t understand, that the regulator doesn’t understand — is really not a good idea no matter who owns it. I think that the degree of complexity that was created in the securities, and the lack of anybody’s ability to really understand how they were going to perform, was simply an error and a bad thing. The fact that the firms that created them were stupid enough to own them doesn’t make me feel any better.

UPENN Wharton Transcript of the Q & A available here.

Hat-tip: Dealmaker.

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