alt Hacker NewsThe assets weren’t AAA, you’re mixing it up a bond concepts. The deal had bonds that were AAA. And if you’re talking about CDOs then the assets were bonds which were usually BBB or similarly cuspy bonds.
You should learn about securitizations. It’s actually interesting. But people talk about it colloquially and so incorrectly that it’s mind dumbing.
Here’s a simplified example of how you can take something and turn it into a safe investment:
Suppose you have 10 loans and each has a 50% chance of default. Ignore coupon, and say they are $10 each. Expected value is $50
If you were to put this in a deal and cut it up into tranches, say the first tranche gets the first $10, this would be your AAA bond because odds of getting paid out you $10 would be > 99.9%. The equity (bottom tranches) would pay a lot less. For instance the expected value of the bottom half would be considerably less than $50 that is being promised. So there’s upside since you’ll be paying cents on the dollar and even though in the median scenario you’re making nothing, you have to weight the expected values of each scenario to figure out how to price it.
The problem w this model is that it only works if assets are relatively uncorrelated which wasn’t true (it was true in the past but ignored systematic risk and adverse selection in originations).
What this has to do w musk or spacex I’m still not sure
Replies
> this would be your AAA bond because odds of not getting paid out you $10 would be > 99.9%
I think you meant "the chances of getting paid", not of not getting paid.
> The problem w this model is that it only works if assets are relatively uncorrelated (it was true in the past but ignored systematic risk and adverse selection in originations). What this has to do w musk or spacex I’m still not sure
What this has to do with with SpaceX is that there's the same blatant disregard for sound financial analysis by the very institutions that were/are supposed to know better. The NASDAQ 100 fast track decision is a similar level of financial malpractice as the ratings agencies slapping AAA on things that they knew were little better than junk. The abuses of the subprime mortgage originators were well known long before the actual meltdown. As were those systemic risks you spoke of. They were ignored by those whose entire job it was to not ignore them, and they sold out their credibility for a quick buck. If you can't see the similarities to the present situation then I can only wish you luck.
Are you familiar with how crypto tumblers work?
Just to well actually your well actually...
What you've described is how the base level mortgage-backed securities (MBSs) work. The tranches work because there actually exist mortgages that are at lower default risk (high home equity, well qualified borrowers, etc.), and the senior tranches are effective in capturing their underlying safety. What CDOs did was to take the lower, riskier tranches of MBSs from various sources and repackage them and divided them into tranches again. Then they got the ratings agencies to rate the top tranches of the CDOs as AAA as well. It's as if a teacher graded several classes and then took everyone that got a C or below from all the classes and then graded them on a curve again. And suddenly a lot of the C students became A students. It was outright financial insanity. Well, mixing a rocket/satellite company with a couple of also-ran AI outfits and the walking corpse of Twitter, and then calling the whole thing SpaceX and valued at $1.75T is a similarly level of financial insanity to me.