Citigroup's boss is out marketing synthetic collateralized debt obligations (CDOs) -- financial derivatives that let buyers make leveraged bets, in this case on the health of corporate America. Sound familiar? The huge market for these products played an infamous role in the 2008 financial crisis. And back then Citi was forced into a taxpayer bailout after suffering huge losses on similar securities, tied to mortgages. But it says this time things are different.
From Bloomberg:
Read Full Article »“There's a tremendous amount of residual skepticism about this product,” said David Knutson, the head of credit research for Americas at Schroder Investment Management, which oversees more than $500 billion. “If you are out there trying to sell it, you better know what you are talking about.”
Typically, these CDOs pool together about 100 different credit-default swaps tied to various companies, which are then sliced into varying levels of risk called tranches -- senior, mezzanine and equity. Over the life of a deal, which generally lasts two to three years, the swaps generate a steady stream of income for “long” investors (and are paid by “short” investors on the other side of the trade who want insurance against a potential default).
The equity tranche has the biggest risk of getting wiped out if losses from defaults exceed roughly 5 to 7 percent, and nets the highest returns.
