The Synthetic CDO Shell Game Could the hottest market in all of fixed income be a disaster in the making?
By Bill Shepherd
"One of the questions people have to ask themselves is, how will these synthetic instruments behave in times of stress?" says Leslie Rahl, a former Citibank risk expert who now runs Capital Market Risk Advisors, a risk consultancy in New York. Normal risk modeling only approximates normal markets-the real test comes in extreme markets. And as Rahl likes to say, "We have a once-in-a-lifetime crisis every three or four years."
"If you want to get out early, it costs you," says CMRA's Rahl. "People don't fully understand the degree to which, if over-the-counter markets freeze up, there could be substantial differences between what a theoretical model tells you something is worth and where a buyer and a seller are willing to transact."
Even the skimpy historical record may be distorted by the ways that new entrants change market behavior. "There have been significant changes in how the credit markets work," notes Rahl. For instance, "the role of banks in working out bad credits has changed dramatically. Bondholders now play a much more significant role. So looking at data from the 1980s, probably there's little resemblance to the workout patterns and partners of today."
May 16, 2005