Synthetic CDOs and the Counterparties to Mortgage Credit Default Swaps

Summary

The document raises questions about how synthetic collateralized debt obligations obtained enough credit default swap exposure to reference mortgage-linked assets, and who took the opposite side of those contracts. It distinguishes cash CDOs, described as bonds backed by mortgage-related debt, from synthetic structures that use credit default swaps to create credit exposure without originating additional mortgages. It also asks whether the market’s supply of protection buyers and sellers could support the scale portrayed in a popular account of the crisis.

The text is a question rather than an answer: it does not identify particular counterparties, trace the contracts, or establish the cited ratio between real borrowers and synthetic positions. Its value is as a prompt to examine how CDS exposure can be created and distributed among market participants, and how synthetic structures can multiply exposure to a reference pool. Any conclusions about who initiated the market or how much speculation existed require evidence beyond what is provided here.

Key ideas

• Synthetic CDOs use credit default swaps to create exposure to mortgage-linked credit without originating new loans.
• A CDS has counterparties on opposite sides of the protection contract, but the document does not identify them.
• The question highlights how synthetic positions can increase exposure relative to the underlying mortgage debt.
• Claims about market scale and participant ratios are raised but not substantiated in the text.

Tags

# 77692


# If Micheal Burry created the Credit Default Swap on mortgage bonds, how did the CDO managers find enough CDS to fill their synthetic CDO's?












In the book The Big Short, the author mentions that Michel Burry came up with the idea of creating CDS on mortgage bonds because he assumed the market was not sustainable due to too many subprime loans.

Later the concept of a CDO is mentioned. Which basically means a bond of mortgage bonds with different risk levels. They also mention synthetic CDO's, which are supposedly CDS (bets against) the regular CDO's, because they had trouble finding new mortgage loan creditors, using speculators as pseudo homeloan creditors.

So my question is, did the CDO Manager take over the idea of a mortgage CDS from Micheal Burry? Also who were counterparty of the CDS, the one who paid the premiums?

The book makes it clear only a handful of funds new of the impending catastrophe, who were all the people they needed to create enough synthetic CDO's to satisfy the market. They mention that the ratio of real creditors to speculators in the CDO space was 50 to 1. Wouldn't they need an absolutely mindboggling amount of speculators to make that happen?

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.