:LPE:

It’s the mother of all moral hazards, to use an ugly term.

A bankruptcy law is being used to structure a deal between those who sold and rated ABCP and those who bought it which would see most of it converted to long-term securities and some of it at a loss to the original investment, all of which were meant to be low-risk, secure near-cash securities. Part of the deal ensures that no party to any of the ABCP has the right to sue - you’re not allowed to opt out and try your chances against someone in court.

This may be the fairest way to deal with the problem - we will never know, because most of the information about this deal is hidden from public scrutiny. There are bailouts going on around the world, so this is not all that unusual in today’s circumstances. It also falls in line with the broad contours of financial sector crises and bailouts ever 5 years or so for the past 25 years. It certainly gets the banks and credit rating agencies off the hook pretty well, and a few large investment funds. Pension funds probably do ok too. But unless it comes with some pretty key reforms in financial practices or indeed regulation, it can and likely will happen again.

is the name that analysts of financial markets of a quantitative inclination have begun to use to describe the events of last August. (You will remember that the credit markets failed to turn over debt, and a whole raft of over-priced securities tanked. Among other effects.)

Black Swan is their risk-management euphemism for a 1-in-10,000 year event, a probabalistic assessment of the chances of, say, the sub-prime markets collapsing or asset-backed commerical paper freezing up. Evidentally, we have a case of a beautiful model destoryed by a few ugly facts. Perhaps they mean a 1-in-$10,000 event.

At any rate, the self-diagnosis of the quants for what it is worth at a recent Vancouver meeting was that they: (i) borrowed too much and used it to bet on risky securities (ii) ignored warnings signs such as credit risk spreads or small value spreads on merger arbitrage bets and (iii) used too few “factors” to correlate (read, explain) security price movements in their models. They’ve apparently fixed that now, and are looking for more factors based on actual balance sheets and less borrowed money. Ignoring signs is harder to fix.