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DrBob

Aaa Rated Credit Derivatives Have Same Default Risk As Junk

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CPDOs Rated AAA May Risk Default, CreditSights Says
Sept. 6 (Bloomberg)

http://www.bloomberg.com/apps/news?pid=20601087&sid=aWPHoWei3zOc&refer=home' rel="external nofollow">
Credit derivatives awarded the top ratings by Moody's Investors Service and Standard & Poor's may be as vulnerable to default as high-risk, high-yield bonds, according to independent research firm CreditSights Inc.
Constant proportion debt obligations, known as CPDOs, use credit-default swaps to speculate that a group of companies with investment-grade ratings will repay their debt. An increase in credit rating cuts for investment-grade companies may cause losses that CPDOs would struggle to recoup, CreditSights said in a report entitled "Distressed CPDOs: We're Doomed!''
"If you assume defaults and downgrades come in bunches rather than being evenly spaced out, CPDOs' default rates are more what you would expect for low junk ratings than for AAA,'' David Watts, a CreditSights analyst in London, said in a telephone interview yesterday.
Prices of CPDOs dropped to as little as 70 percent of face value last month.

This might seem esoteric, but it sounds like there has been wholesale misselling of credit derivatives, and irregularities (fraud?) in the rating of these products. I presume that mathematical modelling had suggested these 'CPDOs' were water-tight, but how can you defend giving a cast-iron AAA credit rating to a model that has never been tested in the 'real world'? The credit crunch is running and running - this will be a slow & painful experience. :blink:

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