links for 2007-11-26
Bernanke Effectively Brings Inflation Targeting to the Fed

Leveraged Super Senior Trades and the Liquidity Put -

Felix Salmon writes:

Market Movers: Today we're learning a lot about something known as leveraged super senior trades, or LSS.... In an LSS, investors made a leveraged bet on the super-senior tranches of mortgage-backed securities. But the leverage wasn't the kind of leverage that the Bear Stearns hedge funds used. The Bear Stearns funds simply went to their banks (or "prime brokers", as they're known in the hedge-fund world) and borrowed the money against the value of their portfolios. When those portfolios dropped in value, the prime brokers started making margin calls, forcing the funds to sell their paper at a loss.

An LSS, by contrast... borrowed the money to create its leverage by issuing asset-backed commercial paper, or ABCP... at very short maturities... [backed by] the assets of the LSS. And those investors had two reasons to be sure that they would get repaid in full. The first was that the assets of the LSS, being super-senior, were therefore super-safe... The second was that the banks which created these structures, like Citigroup, promised that they would step up and buy the ABCP if no one else would. That is the famous liquidity put...

Now the ABCP is asset-backed, so Citi could and presumably did take possession of the super-senior paper which was held by the LSS vehicle. The original investors in the LSS will have been wiped out, left with nothing. But the value of that super-senior paper as now fallen so far that it's worth much less than Citigroup paid for the ABCP...