Question by Alex G: Can someone please explain what synthethic CDO’s are?
It’s for my project on the Great Recession. I understand the tranches & securitization process behind regular CDO’s so you don’t have to start at the beginning. Thanks so much
Best answer:
Answer by Mike
Synthetic CDOs are just side bets on mortgages. Typically they have a similar structure as regular CDO except the “senior” tranche is called the “super senior” tranche”. Typically a synthetic CDO is comprised of mortgages from other CDOs. Sometimes the synthetic CDOs are packaged with only the lower tranches of another CDO which then may be known as “CDO squared”.
Typically a synthetic CDO is protected by “credit default swaps” but seldom is the “super senior” tranche protected. It was assumed that since the “super senior” tranche was rated AAA, that tranche would not default but with all the manipulation, it was guaranteed to default.
Most of the problems during the credit crisis were caused by the synthetic CDOs and not the regular CDOs. The “super senior” tranches were the ones that were selling for 20 cents on the dollar (if they could find buyers).
http://www.tavakolistructuredfinance.com/ifr2.html
http://clickbroker.blogspot.com/2008/04/super-seniors-take-control-of-cdos.html
http://www.math.utexas.edu/users/zariphop/pdfs/ProtterTheFinancialMeltdown.pdf
http://www.portfolio.com/views/blogs/market-movers/2008/12/01/whats-a-super-senior-tranche?tid=true
http://www.nakedcapitalism.com/2008/04/merrills-reckless-mortgage-bond-binge.html
http://www.roubini.com/financemarkets-monitor/253166/is_merrill___s_cdo_transaction_with_lone_star_consistent_with_markit_abx_pricing_
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