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Friday, November 09, 2007


cdo liquidations have begun

via calculated risk.

The trustee of a $1.5 billion collateralised debt obligation (CDO) managed by State Street Global Advisors has started selling assets, apparently starting a process of liquidation, Standard & Poor's said late on Thursday.

The trustee of the Carina CDO has started selling the asset-backed securities -- residential-mortgage backed securities and CDOs -- making up the CDO at the direction of the structure's noteholders, S&P said.

much depends on who is buying and at what price. if these sales are to distressed "vulture" funds and the marks are low, the implications for level 3 assets across the banking and insurance industries could be profound -- in time.

but one can expect the banks to fight it tooth and nail -- perhaps even to the point of buying the assets from carina at a much-higher-than-market price.

but it does indicate something -- panic is finally taking hold in structured finance. here's lehman's bond king:

"This is the deepest correction we've ever seen in structured finance," Malvey said in an interview on Friday. "This is now worse than Long-Term Capital. This is so dispersed, so interlocked and the relationships among the various entities are not as evident. This is a painful lesson in financial engineering."

indeed. but, as kevin depew notes at length, this amounts to the first break in trust that may have astounding ramifications.

One of the issues Citigroup was concerned about in their conference call this week; the point at which holders of senior notes say they are no longer willing to risk - important word - risk the fact that current cash flows will continue on without impairment. Consequently, the Carina CDO Ltd. liquidation event is a hallmark move toward risk aversion where the holders are saying, "We no longer are willing to accept the risk of potential cash flow impairment." They are saying, "We just want to get whatever price we can get for the securities."

Now, the important risk for us going forward is that this is not a capitulation event, as equity market participants perceive, but a kickoff event precipitating increased risk aversion across the spectrum, not to mention the creation of "observable inputs" in pricing. As noted in yesterday's Five Things (No. 2, November 15), the new SFAS 157 provisions that firms have implemented require firms, whenever possible, to use "observable inputs" in pricing their Level Three assets. Forced sales, at distressed prices, create "observable inputs"; the result will be revaluation down the line and risk aversion that begets still more risk aversion.

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