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More Questions Than Answers In Cpdo Default

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by Felix Salmon
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Nov 26 2007 12:00am EDT

More Questions Than Answers in CPDO Default

Now that financial reporters are back to work after the Thanksgiving holiday, I'm hoping that somebody will write a story about the CPDO which defaulted last week. The Reuters story raises more questions than it answers, foremost among them the question of what a CPDO was doing with multiple tranches in the first place. Isn't the whole point of CPDOs that they were AAA-rated? So if this tranche was downgraded by Moody's from Ba2 to C, is that only after it was downgraded from AAA to Ba2? Or is this merely the equity tranche, in which case it's much less of a big deal?

After all, the equity tranche of CPDOs is meant to be the part which takes losses. What's more, if 10% of the value of this lowest-rated tranche is still remaining, does that mean that all the other investors in the deal are still whole? And what caused these losses? Was it the general gapping-out in spreads of the financial companies in which the CPDO invested? Because CPDOs were meant to be relatively immune to spread widening. Or were there problems with the roll-over? All answers gratefully accepted.

(Full disclosure: Back when CPDOs were flavor of the month, I was one of the very few journalists who stepped up to defend the structure. I was, clearly, wrong. I will never again trust a credit-rating agency when it tells me that a structured product has a AAA rating. Even if the CPDO market is still, allegedly, "alive and kicking".)

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