Tuesday, March 16, 2010

A note about securitized loans

CLOs pool loans and slice them into securities of varying risk intended to provide higher returns than similarly-rated investments.
-- via Bloomberg CLOs to End 12-Month Drought in Citigroup Deal

Uhm. This is what is wrong with everyone. Have these people never heard of conservation of probability? Slicing and dicing loans doesn't improve the quality of the underlying, it just redistributes risk across tranches and security holders to reduce the variance. Without so much as touching on David Merkel's great point about lower quality in originate-to-securitize loans, the overhead needed to securitize these loans effectively reduces the aggregate return on the whole pool as well as lower the probability adjusted return of the pool.

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