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I hate to use a redditism here, but could someone ELI5 this for me? I got lost somewhere around the first appearance of the word tranch,

by Aloha 11y ago

ianpurton 11y ago
In the financial markets you can buy insurance such that if a company fails e.g. Microsoft, you get a payout. It's called a credit default swap. Deutsche bank sold lot's of this type of insurance. If the markets had turned and some large companies had gone bankrupt they would not have had the means to pay the people who bought this insurance. Basically they took very low quality insurance and re-packaged it as high quality insuarance.
- Zigurd 11y ago
  Excellent explanation. CDSs are insurance. So why can't you buy the equivalent product from an insurer, labelled and regulated as insurance? Because the capital requirements under insurance regulation would have been prohibitive. So why weren't the banks charged with illegally selling insurance products and/or violating insurance regulations? Because fuck you, peon.
ddeck 11y ago
Let me try: Imagine an empty company loans 100 companies $1 each. To get the $100 to loan, that company sells bonds to 2 investors for $50 each. One investor is senior and one is junior. What this means is that if any of those 100 companies default and don't pay back their loan, then the junior investor loses money. The junior investor loses money until their entire $50 is lost, and only then does the senior investor have to suffer loses. The senior investor therefore only has losses if more than $50 of the total $100 loans is lost. This is basic credit tranching in funded format. Unfortunately things get a lot more complicated when instead of $1 loans, we have $1 credit default swaps, which instead of loaning someone $1, you promise to pay them if a 3rd party company defaults. This trade is DB buying protection from a company on a very senior tranche of this type of trade, but they are buying it leveraged, so for example they buy $100 of protection from a company that has $10 of cash inside (provided by the third-party investors), with a promise to pay more if the tranche deteriorates. As far as rationale, the primary purpose of these trades is to offload super senior risk from DB's balance sheet, which they accrued through doing a different type of trade.

I hate to use a redditism here, but could someone ELI5 this for me? I got lost somewhere around the first appearance of the word tranch,

by Aloha 11y ago

I hate to use a redditism here, but could someone ELI5 this for me? I got lost somewhere around the first appearance of the word tranch,

ianpurton 11y ago

In the financial markets you can buy insurance such that if a company fails e.g. Microsoft, you get a payout. It's called a credit default swap. Deutsche bank sold lot's of this type of insurance. If the markets had turned and some large companies had gone bankrupt they would not have had the means to pay the people who bought this insurance. Basically they took very low quality insurance and re-packaged it as high quality insuarance.

Zigurd 11y ago
Excellent explanation. CDSs are insurance. So why can't you buy the equivalent product from an insurer, labelled and regulated as insurance? Because the capital requirements under insurance regulation would have been prohibitive. So why weren't the banks charged with illegally selling insurance products and/or violating insurance regulations? Because fuck you, peon.

ddeck 11y ago

Let me try: Imagine an empty company loans 100 companies $1 each. To get the $100 to loan, that company sells bonds to 2 investors for $50 each. One investor is senior and one is junior. What this means is that if any of those 100 companies default and don't pay back their loan, then the junior investor loses money. The junior investor loses money until their entire $50 is lost, and only then does the senior investor have to suffer loses. The senior investor therefore only has losses if more than $50 of the total $100 loans is lost. This is basic credit tranching in funded format. Unfortunately things get a lot more complicated when instead of $1 loans, we have $1 credit default swaps, which instead of loaning someone $1, you promise to pay them if a 3rd party company defaults. This trade is DB buying protection from a company on a very senior tranche of this type of trade, but they are buying it leveraged, so for example they buy $100 of protection from a company that has $10 of cash inside (provided by the third-party investors), with a promise to pay more if the tranche deteriorates. As far as rationale, the primary purpose of these trades is to offload super senior risk from DB's balance sheet, which they accrued through doing a different type of trade.