Pyburn has some numbers on just how much the notorious "super-senior"
tranches of subprime-backed CDOs are actually worth in the market. It’s probably
no surprise that the junior tranches are changing hands in "the high single
digits," but more to the point the super-senior tranches, she says, are
fetching no more than 60 cents on the dollar, which of course corresponds to
a 40% write-down. By contrast, she says, Merrill’s latest write-down was just
19% on its super-senior CDO holdings.
These numbers are scary enough that there’s a serious chance of a domino effect.
Banks for instance were able to hedge their CDO holdings by insuring them against
loss – but now the insurers are at risk of going bust. The titles of two
blog entries on this subject say it all: "So
Much For Being Hedged" and "Another
word for hedged… leveraged".
We’ve already seen something along these lines at Morgan
Stanley, where the "hedge" on its bearish mortgage-bond bet seems
to have been much riskier than the original bet itself. But I have to say that
the Morgan Stanley losses don’t make a lot of sense to me. For all the talk
of "negative convexity", the trade looks as though it was after
all a simple long-senior, short-junior play. If you really wanted to make a
bearish bet on mortgage bonds, why on earth would you fund it with a long position
in mortgage bonds, of all things? Why not use emerging-market debt,
or Treasury bonds, or something – anything – which wouldn’t go down
when mortgage debt fell in value?