Reuters Drops a Bombshell: The Big Short Doomsday Machine Is Back

Instead of subprime mortgages being targeted this time around, what’s being stuffed into the synthetic CDOs is corporate debt, which has exploded over the past decade.

By Pam Martens and Russ Martens and cross-posted from Wall Street on Parade

Margot Robbie in The Big Short
Margot Robbie in The Big Short Explaining Subprime CDOs

In what can only be described as a new low in defining deviancy down on Wall Street, Thomson Reuters’ International Financing Review (IFR) reported this past weekend that some of the biggest names on Wall Street have returned to creating and/or trading synthetic collateralized debt obligations (Synthetic CDOs).

The products were a major factor in bringing the U.S. financial system to the brink of failure in 2008. Synthetic CDOs also resulted in hundreds of millions of dollars in fines and reputational damage to these same Wall Street behemoths as investigators found that the firms were allowing hedge funds to pick “crap” subprime mortgage bonds to stuff in the CDOs in order to make windfall profits for the hedge fund, which shorted (bet against) the CDOs. The Wall Street firms had full knowledge of what the hedge funds were doing but, nonetheless, peddled the investments as sound to unsuspecting investors. In some instances, the same Wall Street firm that was selling the product as a good investment to public pension funds, school districts, churches and insurance companies, was also making short bets itself against the CDO. In at least one case involving Goldman Sachs, it placed a 10 to 1 short bet on failure of its own product.

Writing for IFR, Christopher Whittall reports that “Trading volumes in synthetic collateralised debt obligations linked to credit indexes are up 40% this year, according to JP Morgan, after topping US$200bn in 2018 on the back of three years of double-digit growth. Meanwhile, analysts predict more than US$100bn in sales of bespoke synthetic CDOs in 2019 following an estimated US$80bn of issuance last year.”

Who are the major players in this market? According to Whittall, Citigroup is a major player while Deutsche Bank has “an eye on expanding in this market.” Our own sources tell us that Morgan Stanley has also structured deals in the past two years.

The bombshell here is not about the trading of synthetic CDOs. Firms can do that all day long without exposing their balance sheets and the U.S. economy to collapse. The bombshell is that the bespoke (custom-made) synthetic CDO market has returned to Wall Street and if analysts are predicting $100 billion this year after an estimated $80 billion last year, that means the real secret number is dramatically higher. Those figures also reveal nothing about how much shorting is going on. That could be 10 to 1 or even 20 to 1.

Instead of subprime mortgages being targeted this time around, what’s being stuffed into these bespoke products is corporate debt – which has exploded over the past decade, in no small part because publicly-traded corporations and Wall Street banks are being allowed to prop up their share prices through stock buybacks financed with debt

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