Right Honourable Mug Punters

February 28, 2009 12:52 PM
By Paul Wilmott
wilmott.com/blogs/paul

Remember CDOs? Of course, you do...although no one is trading these monsters anymore they continue to wreak havoc to the global economy.

We still teach about them on the CQF. Why? Maybe they'll come back one day, maybe with a different acronym, or if they don't then they are at least a fantastic teaching aid for showing how not to model and how not to risk manage.

Hang on a second. Have they really disappeared? I'm not so sure they have. What's that recent deal that the UK Treasury has just done with RBS? It looks scarily familiar...something to do with $325 billion of toxic assets (no doubt including a few CDOs and CDO^2s) and divvying up different levels of risk?

The balance sheet of RBS is £2.3 trillion. In return for £6.5 billion in some dodgy non-voting shares the UK Treasury is going to be insuring some of that £2.3 trillion. The first £19.5 billion is RBS's responsibility, after that the taxpayer takes care of 90% of the rest of the $325 billion.

Sound familiar? Yes, the UK Treasury has just got itself the mezzanine tranche of a CDO!

Observations:

1. This "Mother Of All CDOs" that the Treasury owns is mezzanine tranche, the hardest tranche to value and risk manage.

2. Assuming there are CDO^2s in the portfolio this is now officially a CDO^3.

3. Worst of all, the premium paid to the UK Taxpayer is £6.5 billion in RBS shares. Of course, if things go wrong, as they probably will, then that premium will plummet as the RBS share price plummets. Note to Lord Myners, Alistair Darling and Gordon Brown: When you buy insurance on company X, buy it from company Y, not company X itself.

4. A fall of a mere 8.2% in the value of the toxic assets will wipe out the £6.5 billion. And that's best-case scenario in which the RBS share price doesn't fall!

5. Finally, the shares are non voting so as to give the impression, albeit rather feebly, that RBS has not been nationalized. Look, the Taxpayer owns 90% of RBS, and can vote on 75% of the shares. Why keep up the charade? Nationalize all dangerous banks, across the globe, immediately. Guarantee the deposits of the man in the street. And clean up the mess in an atmosphere of relative stability.

The UK Treasury is being advised by a bunch of dodgy Sirs and Lords, none of whom have a clue about what is going on or what to do, none of whom have any qualifications in risk control. But I'm sure all of them are jolly good chaps to have a glass of port with in the clubs of St James's.