Long Live Synthetic CDOs – Bloomberg 06-23-13

Salient to Investors:

William D. Cohan writes:

What caused the financial crisis remains unheeded and serious trouble is brewing. The debt markets have once again mispriced risk when junk bonds yield a mere 5 percent. Wall Street still suffers from inadequate risk management and improper incentives. Until these problems are fixed, the next financial crisis is inevitable.

The FT recently reported how Morgan Stanley and JPMorgan Chase tried, and failed, to put together the first synthetic CDO since the onset of the 2008 crisis.

Just because CDOs might have played a role in the crisis does not mean that they are flawed. It more likely means that the rewards bankers received led them to create more and more of these deals with lower and lower credit standards. A familiar pattern of behavior on Wall Street: junk bonds in the 1980s, Internet stock offerings in the 1990s, and mortgage-backed securities in the 2000s. All innovations in the democratization of capital are a good thing, and in every trade, there is a winner and a loser.

Financial innovation did not cause the crisis, many things went wrong nearly simultaneously. Chief among them was, and remains, an incentive system on Wall Street that rewards bankers and traders who take asynchronous risks with other people’s money.

Read the full article at  http://www.bloomberg.com/news/2013-06-23/long-live-synthetic-cdos.html

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