Synthetic securities are not so strange

Synthetic securities are not so strange. Many retail investors own them.

If you hold a commodity ETF or a equity ETF that tracks its benchmark via futures, you hold a synthetic security. Like a synthetic CDO, commodity and equity ETFs are investment vehicles that hold very vanilla “collateral securities” (like Treasury bills), but simulate exposure to some other thing by taking positions in derivative markets. For example, if you were to purchase the PowerShares DB Agriculture ETF (DBA), you would hold an interest in an entity that holds T-bills and takes futures positions in commodities like corn, wheat, and sugar. Despite the fact that this entity is synthesized in part from “zero-sum” derivatives, your shares of DBA constitute “securities” in every common sense: They are standardized, transferrable, claims on a business entity. The fund holds assets (the T-bills) that serve to secure claims that may arise against it in the course of doing business. Shares are limited liability instruments; investors can not be held liable for amounts beyond what they have invested.

It is possible to borrow and sell short shares of DBA, but at the fund level, the statement “for every long there is a short” is no more true of DBA than it is of IBM. It is true that the long futures positions held by the ETF are necessarily matched by short positions by some other investor. Formally, the short counterparty is likely a single clearinghouse. But the clearinghouse is just an intermediary; in an economic sense, the positions opposite DBA are held by a wide variety of market participants whose motivations may include both speculation and hedging, who may or may not have information or strong beliefs about future price movements.

The fact that DBA is “synthetic” may or may not have economic significance. If you review the prospectus of a synthetic ETF, you will be informed of various risks relating to the structure of derivatives markets. But the ETFs are intended simply to offer exposure to a basket of commodities more efficiently than a fund that physically warehoused the goods would. Commodity ETFs track the experience of an entity holding real goods with varying degrees of accuracy, but most investors view their positions as simply being long the commodity.

There are lots of important differences between a commodity ETF and a synthetic CDO. Synthetic CDOs are usually leveraged. Some synthetic equity ETFs are also leveraged, although they manage leverage very differently. Unlike ETFs, claims on synthetic CDOs are divided into multiple tranches, which is intended to create different classes of shares that are more or less speculative. The derivative positions held by synthetic CDOs are usually over-the-counter credit default swaps, and are likely to be less liquid than the futures positions held by a typical ETF.

I don’t mean to overstate the analogy. A synthetic CDO built from credit derivatives on the hard-to-digest bits of mortgage-backed securities is very different from an ETF that provides exposure to commodities. To the degree that it is important to draw inferences about the nature and intentions of a fund’s counterparties, one would conclude that the CDO and ETF trade with very different populations. A synthetic CDO is constructed in a manner intended to provide stable and predictable cashflows to more senior investors. Commodity ETFs are volatile all around.

However, the statement “a XXX transaction necessarily included both a long and short side” is as true for commodity ETFs as for synthetic CDOs. That statement may or may not have some economic significance. But it does not in itself imply that there are one or a few counterparties taking concentrated speculative bets specifically against the holdings of the fund.

This piece is inspired by comments of James Kwak, despite his poor taste in pundits. It is also intended as a bit of an answer to Arnold Kling, who wonders whether claims on a synthetic CDO could be considered securities.


31 Responses to “Synthetic securities are not so strange”

  1. JKH writes:


    I think you’re unnecessarily restricting the meaning/context of the original statement “for every long there is a short”, and identifying some false logic that isn’t necessarily there.

    The statement is more fundamentally true in a slightly different context than what you’ve considered, I think.

    Consider for example a simply made-up cash investment vehicle with IBM stock (or bonds) as the asset and “investment shares” as the liability. Then for every long (vehicle investment shares), there is a short (IBM stock or bonds considered as an obligation of IBM).

    Consider the same investment vehicle with treasury bills as the cash asset and investment shares as the liability. Suppose the investment vehicle also has purchased IBM stock futures and/or written CDS protection on IBM bonds, in order to replicate the corresponding cash IBM instrument through derivatives.

    This opens up the possibility/likelihood/near certainty that the counterparty for the derivative is somebody other than IBM itself.

    Similarly, with any such synthetic vehicle, it is a near certainty that the counterparty for the derivative structure is somebody other than the issuer.

    Therefore, the statement “for every long there is a short” is fundamentally true and meaningful in the distinct and comparative sense that the counterparty risk configuration has expanded beyond the issuer/holder cash nexus. Suddenly, there are three actors in the transaction – the “risk originator” (IBM) and two counterparties – rather than a risk originating counterparty and a risk absorbing counterparty.

    “For every long there is a short” in the case of the synthetic transaction then identifies/emphasizes the fact that the “risk originator” is no longer the short counterparty, and there is a new short counterparty separate from the “risk originator”.

    So IBM is no longer the short counterparty at the micro level. But it remains somebody’s counterparty at the macro level. Because somebody holds that cash instrument.

    Therefore, at the macro level, for any given “risk event” emanating from the risk originator IBM (stock or bond price change), there is one additional short position risk event.

    Whether that short position response constitutes a speculative type price event or a hedging price event is not the issue in my view. It could be either, depending on the pre-existing macro and/or micro risk (asset liability management) configurations.

    I think that this macro inference of there necessarily being a new short is the rightly intended meaning, as opposed to your more restrictive interpretation whereby you identity the misinterpretation as that of a short with a necessarily speculative rather than a hedging interest. I’m not sure that different meaning is always meant in the original context.

  2. rootless_e writes:

    Wait a second: when IBM sells you a share, it’s not taking a short position at all. The purpose of share issuing is to raise money. IBM is selling part of their future earnings in exchange for an investment. And when you then sell that share to a third party, you may or may not have a short expectation, but you are not in the position of having your return depend on a fall in IBMs stock and the buyer’s future prospects are severed from yours. On the other hand, for a synthetic CDO the buyer of protection has an interest in seeing the reference asset crash – his or her return is based on your loss. And the seller of protection has an interest in the protection buyer losing money – paying premiums for nothing. The two situations are fundamentally different. I can sell my IBM share, invest the money in Dom Perignon and be perfectly happy if IBM triples in value. But I cannot purchase a protection policy, like the one Paulson purchased, and be happy if the housing market booms.
    The fundamental difference between a bet or an insurance policy and an investment can be obscured if you play around with short/long terminology, but it’s not similar.

  3. rootless_e writes:

    I also gotta point to the obvious but easy to forget utter social counter-utility of the synthetic CDO. It’s essentially a device for keeping capital costs high by legerdemain. People who can’t find productive investments and want safety should buy government bonds, reducing the tax burden on the public by driving down the financing costs of state debt. Banks with too much capital can reduce borrowers costs. The entire financial and legal system has been distorted by the gravitational force of oligopolistic finance in an effort to maintain an artificial profit level for lending money. But socially, borrowing money for projects with high payback probability should be cheap. We want people to borrow to finance their machine tool plant machinery or for letters of credit on a shipment of goods. However, we are in a situation where wind power is considered a poor investment because it does not offer artificial rates of return. The idea of the financial world is that finance should earn the lions share of profits, but it’s obviously more useful for society to be structured so that banking is a low profit margin business.

  4. […] Synthetic securities are not so strange. Many retail investors own […]

  5. JKH writes:

    Every long requires a short in the sense of gross longs and gross shorts. This says nothing about the related full portfolio position of the gross short as being net long or net short.

    The SEC Goldman affair is in part an investigation into the right of a bank’s client to be proprietary and smart at the same time. This is irrelevant to the more important risk issue, which is the right of behemoths like ACA, AIG, and Citigroup to be option writers (protection sellers), and the risk assessment and capital adequacy requirements and capabilities that pertain to that right. The primary risk here is not the right to buy protection – whatever the short/long, gross/net interpretation is – it is the right to sell protection.

  6. JKH writes:

    It’s pretty obvious the wheels are coming off this thing.

    See ya later, Mary Schapiro.

  7. M writes:

    I’m slightly at two minds about this though. Fair enough, retail investors do own synthetic securites – but do they know that the ETF they invest in does not hold the underlying? I’m not so sure. Retail investors are typically unsophisticated.

    Also, there are ETF structures that do hold the underlying cash equities or commodities, such as the iShares equity ETFs and one or two physical gold ETFs.

    The risk that I’m not sure retail investors are aware of, even IF they know that Deutsche ETFs are swap based, is the counterparty risk.

  8. rootless_e writes:

    What’s so wonderful about ETFs, while we are at it. The premise that one should be able to produce a return above treasuries from speculation on market indexes strikes me as unexamined.

  9. Jon W writes:

    The comparison between ETFs and CDOs is somewhat valid, but not entirely correct. While both are structured pools of investments that can contain synthetics you’re not comparing the correct trades.

    When retail investors trade ETFs, there is generally no creation of new shares of the ETFs. Instead they buy on a SECONDARY market. The MACRO LEVEL GROSS EXPOSURE remains the same. This is key. Only institutions can create new ETF shares through in-kind exchanges. Another important point.

    In the case of ACA and IKB they weren’t trading the CDO on a secondary exchange. No one possessed the CDO in the first place. What they had to do was agree to enter into counterparty agreements to create new pieces of the CDO. These transactions are on a primary market. Entering into these trades is increasing the MACRO LEVEL GROSS EXPOSURE. It’s the difference between transfering a security that already exists vs creating one. When you add GROSS EXPOSURE to the system there is a long and a short in the sense that an additional two parties have economic interest. In a transfer there is no net addition of economic interest.

  10. […] Steve Randy Waldman, “Synthetic securities are not so strange. Many retail investors own them.”  (Interfluidity) […]

  11. laugher writes:

    With regard to the Abacus transaction, and “the other side of the trade”…. It’s clear that the synth cdo needed “another side of the trade”, since its based on a portfolio of cds’s on the underlying mbs, which are 2 sided bets. But I think what Paulson purchased cds protection on was the tranches of the synth cdo itself. To the investor, while there is an expectation of negative sentiment in the underlying cds’s, I don’t think there is necessarily an expectation of major negative sentiment in the exact capital structure of the cdo being marketed, ready to pounce as soon as the deal closes! To me this whole deal seams to be a fraudulent (or at least unethical way) for goldman to obfuscate Paulson’s desire for a huge negative bet on the mbs. If not, why not just sell Paulson a bunch of cds on the underlying mortgages directly? (answer: probably because no one would buy the other side).

  12. rootless_e writes:

    Banks would not have bought the other side of plain CDSs because the ratings agencies and regulatory authorities wanted all this meaningless ancillary crap attached, apparently so that ratings agencies and investment banks had more commissions.

    Remember: IBK got its side of the deal certified as suitable for regulatory cap requirements.

  13. Steve Randy Waldman writes:

    Great comments. I’m sorry that I can’t respond in detail right now. On the bright side, my absence mechanically imparts an upward bias to average comment quality.

    I wanted to make a quick point back to Jon W — many ETFs, including some synthetic commodity and leveraged equity funds, allow the fund to expand and contract based on investor interest. That is, it is not necessarily true that a purchase of DBA is simply a transfer of a share. It may in fact cause the initiation of net new futures positions (if there are new purchases on net).

    In my mind that is more a difference than a similarity, with respect to ETFs and an ABACUS-style static synthetic CDO, since the CDO only establishes net new positions upon initiation, and winds them down over time. But it seemed worth pointing out.

    Again it was not my intention here to push the analogy between futures-based ETFs and synthetic CDOs too far. They are very different beasts.

    But though the lives of a bats and a baboon are more similar than different, they both have beating hearts, similar DNA, warm blood. The tools of “high finance” may be complex, but they are made of familiar components that people can make sense of, and that shouldn’t be relegated to some priestly class. The basic trick that makes a synthetic CDO possible is the same trick that makes a synthetic commodity ETF possible. The intricate tranching of a CDO is just a careful elaboration of the debt/equity hierarchy any small businessman understands. Yes, there is real complexity, and the mathematical tools used to model and value structured credits are important for the people who actually price and trade. Things can always be misunderstood.

    Still, an intelligent generalist can get a rich qualitative grasp of how these tools work and what they are for. Citizens oughtn’t leave these issues to “experts”, who may indeed be more knowledgeable but whose interests and perspectives are necessarily unrepresentative of the broader public. We can and should demystify finance. Hearing the word “synthetic” should not cause an intelligent person to sweat and run screaming for their financial advisor.

  14. glory writes:

    sort of OT and just an idea, simplistic and in no way novel, but something i’ve been thinking about, trying to generalize the concept of non-limited liability ‘solutions’ being floated around by the likes of robert reich, michael lewis and james grant,* is the notion that risk (nevermind knightian uncertainty) should remain or be located with those most able to understand it… the corollary being that when risk is offloaded to those less able, then overall risks actually increase.

    which of course brings one back to the negative ‘pollution’ externalities that andrew haldane,** for one, has been talking about and trying to find the best ways to internalize (social/utility) costs… so if high financial sector profit margins are evidence of inefficiencies*** — barriers to entry, information asymmetries, etc. — not commensurate with their economic ‘value added’,**** aka ‘looting’, then no less an authority than nobel prize winner elinor ostrom might suggest public shaming as “one key to managing the commons” :P


    *** (and dominance of economy-wide profits)
    **** – “Every day I go to work in the Bubble that is Wall Street. A bunch of self-important ass clowns that think they somehow deserve or have earned their outsized compensation. We move paper from one side of the desk to the other and call it ‘PnL’… and the idiots in this business think they’re talented enough in doing so that they *deserve* to make $4mm bucks a year…”

  15. glory writes:
  16. Jon W writes:

    SRW – To your point of demystifying finance and allow people to understand that a synthetic is not that strange or foreign, I totally agree. I also agree that a security being synthetic or even a ‘portfolio’ being synthetic does not imply that the opposing side has a concentrated short/long side. Where I disagree however is that in the case of CDOs the term synhetic does imply a concentrated short/long position.

    It lies in the very big difference in how new ETF shares are created vs. how more synthetic CDOs are created and why in CDOs you can infer a concentrated position and in an ETF you cant.

    Lets take the case that we’re creating new shares of ETFs which individual retail investors cannot do. Assume we’re an institution. In the creation / redemption of ETF shares we go and purchase or enter into contracts of the underyling securities (Futures, stocks, etc.) and then deposit them as a basket in-kind for new shares of the ETF. Since the underlyers even the contracts are traded on exchanges there is generally no concentrated bet against the basket. For a basket of futures the individual future contracts will come from all different sources to form the basket, which is then deposited in exchange for ETF shares. When you create new shares of ETFs, you are not facing 1 counter party, you’re facing all the different counterparties represented by that basket. There is effectively no “SHORT” side because there is no one taking that position at a portfolio level.

    With the underylers of the CDO this is very different. A) CDS’s dont trade on exchanges. B) In the creation of new synthetic CDO positions, the LONG is forming agreements with many different individuals to form the basket of contracts, he is going to one specific counterparty, the short side. Here there is a SHORT side because there has to be someone taking the opposition at a whole portfolio level.

    The basic discussion/argument we’re having is if an investor can infer that in the creation of a synthetic CDO there is someone taking the exact opposite bet. With Synthetic CDOs the answer is yes, and it is because it is a CDO that is also synthetic.

    In an ETF it is no, regardless of if it is synthetic or not. Hence why I don’t think the analogy and comparison to the ETF is very valid for discussing Abacus outside of saying ‘synthetics are not strange’

    Perhaps the best way to describe it so everyone can understand is this:

    A shape that has equal sides is not always a square.
    A shape that is a rectangle is also not always a square.
    A shape that has equal sides AND is a rectangle is ALWAYS a square.

    Being long in a CDO does not always mean there is an exact opposite short.
    Creating a long position in a synthetic security does not always mean there is an exact opposite short.
    Creating a long position in synthetic CDO always means there is an exact opposite short.

  17. Jon W writes:

    should read:

    B) In the creation of new synthetic CDO positions, the LONG isn’t forming agreements with many different individuals to form the basket of contracts, he is going to one specific counterparty, the short side.

  18. laugher writes:

    In the Abacus deal, was Paulson the short side of the of the underlying cds, or did he buy cds on the offered tranches of the resulting abacus security? (I thought the latter). Since the securitization is supposed to be safer than the underlying assets, a cds against the resulting synth cdo tranch seems like a different “bet” than the underlying basket of cds’s put into the cdo. A negative bet against a tranch not only suggests negative sentiment on the underlying mbs, but also on the pricing and safety of the synth cdo structure itself. Can anyone straighten this out for me?

  19. Jon W writes:

    “A negative bet against a tranch not only suggests negative sentiment on the underlying mbs, but also on the pricing and safety of the synth cdo structure itself. Can anyone straighten this out for me?”

    You are spot on.

    So the way securitization provides “safety” is through diversification. Let’s just take a normal cash CDO. If you were to buy all the tranches of a CDO it shouldn’t be any safer than buying all the underlying securities. It’s basically the same thing. The reason CDOs exist is that when you buy a single bond/mortage backed security you can’t isolate out the different parts of the risk / reward. (One example for instance: the coupon payments later in the life of the bond are less likely to be paid than the ones earlier.) What the tranching of the CDO does is create a structure that lets you redefine how you want payouts to work as well as how losses work.

    On the whole however if you were to be the sole possesor of the whole basket of securities it would be no different either way.

    The reason that Paulson and others wanted to use CDOs was precisely because they wanted to isolate particular pieces that they saw were mispriced. What they saw was that when managers like ACA created the CDOs, many of the senior pieces, “the safest” had risk / returns that were completely out of whack. Essentially the structure of the CDO and the terms of each tranche are a ‘price’ on the risk associated with the tranch.

    By shorting the senior tranche his bet was not only that subprime mortgages were going to fail, but also that there was a major error in the risk / reward profile of that piece in particular. Shorting other tranches would be the same bet, but have less margin of safety.

    Having been at one of his Paulsons presentation, the thesis behind these trades were that CDOs were being structured such that the senior pieces were paying interest that implied a VERY VERY low rate of default. Since it was so low, even if paulson was wrong he wouldnt be paying a ton of money in terms of insurance. Obviously he believed that the default rate was many multiples higher than what
    it really was.

  20. laugher writes:

    Interesting… certainly makes the whole thing a little more nefarious in my mind. Since Paulson’s intent was to bet against the structure itself, not just the underlying mortgage bonds, it’s even more clear why one would want to keep his intentions from ACA. Sounds like ACA was effectively rolled by Paulson & GS.

  21. JonW writes:

    See but that’s the point. There should be nothing nefarious about it. If you structure it honestly and accurately, then this issue shouldn’t exist. It’s common practice in many exchanges that you simply ask for a quote, bid and ask, you don’t assume the guy is going to make the trade either direction.

    On the floor of the AMEX options exchange for instance where I once worked, traders could approach the specialist and ask for a quote. Either on a put, a call or on more complicated trades like a put spread, butterfly, call spread and calendar spread where you have multiple options adding up into a single portfolio bet. The quote would be a bid and ask for the entire transaction. This goes to neutralize any ability the specialist / market maker would have of gouging you because they know what you intend. If you assume they’re going to do one thing and make a quote that reflects this you leave yourself open to arb opportunities hence why you should price it fairly.

    Why should Paulson’s intentions change how the pieces are structured? The basic idea is that if things are structured and priced fairly, there should be no opportunity to take advantage of it. After all, even after picking the reference securities, structuring the payout, ACA nor anyone was actually obligated to invest in it. If ACA’s pricing of risk was related to Paulsons intentions then they could effectively lower interest / coupons when Paulson wanted to long , and take the other side. Or raise the payments when Paulson was short.

    Effectively what ACA was being asked to do was in many ways structure and make a “market” on the two sides of the CDO. I’m pretty sure no one here would be happy if when they invested and announced their intentions to buy/sell something the person changed their price.

  22. JonW writes:

    Addendum to above:

    It’s no different than me asking for a quote on an APPLE call option the day before their earnings. If I have a strong conviction that apple would rise a lot should the market maker suddenly raise his price? Of course not. Each and every person here who has ever invested would say the same thing. No one knows at the time if I will be right or not. Certainly with my strong opinion I don’t think the options are priced fairly. But to the market they believe it is. The whole concept of investing in the first place is to find the securities that are not being priced fairly. Should my announcing the intention to buy apple options suddenly change the entire market/price? No if the market makers are being unbiased and fair.

    At the time the dominant view was that these CDOs were being priced fairly and that they were not doomed to fail. If everyone thought they would fail, they would be priced very differently.Much the same way the price of the apple options reflects expectations on apple. Paulson obviously disagreed with the market view. There is nothing material about his wanting to sell, he has no inside information regarding the underlying securities anymore than anyone else. That would be like saying that my view on apples earnings was material information. Unless he or someone were actually the guys paying the mortgages in the underlyers how does it matter?

  23. laugher writes:

    I think constructing a security is way different than making a market in options. In a security (or a company) there a whole bunch of fiduciary responsibility that is supposed to funnel into it making money, and providing a return for its (long) investors. . It would be kind of like starting Apple in order to short it. Isn’t it reasonable to expect that those involved in launching a new security want to see it prosper? If not, isn’t that at least misleading, if not fraud?

  24. JonW writes:

    It’s not a security though in that sense. It’s not an investment in a company or a stock. It’s a two sided speculative bet. It’s no different than a book maker setting the lines for an NCAA sporting event. That’s why the fact it was synthetic is important.

    Goldman’s fiduciary duty can’t be to the long side. It’s to both sides. To argue that GS’s responsibility is to provide a return for its long investors is to say that their responsibility is to sucker the shorts.

    One of the reasons I believe there is an extra emphasis on this matter is that Paulson made money being on the short side of the transaction. For whatever reason there is huge negative connotation with betting against any market / security even if it provides a very needed function in the markets. I am 100% certain that if Goldman made a ton of money on the long side even while its clients lost money shorting securities no one would really care.

    Right before Lehman went under for instance David Einhorn consistently made his case for why the company was a short. Except that even though he was right, and even with his up front explanation, the accusation was that he was trying to manipulate the markets. There is a prevailing public opinion that profiting from the short side of a transaction is somehow evil or underhanded. It’s really somewhat idiotic.

    If people want to find cause for the collapse of bubbles or the creation of financial crises it’s easy to find the culprit. It’s all the people from the homeowner up to the investors that think they should always easily make money and make speculative financial decisions on these assumptions. It’s the speculation on the way up, not the way down that’s the issue. In fact if there were sufficient negative bets in the early periods of these bubbles, the bubbles wouldn’t exist in the first place.

  25. laugher writes:

    Hmm… I’m not sure I agree. I understand that the underlying cds were a 2 sided bet. But wasn’t the result of the securitization a (supposedly) AAA rated investment grade security? Isn’t the offering of such things supposed to be regulated to protect the long interest? The purpose of the financial markets is supposed to provide a vehicle for money to find good productive (long) investments. The shorts serve an important role, but surely at the macro level the financial markets need to favor the longs. I don’t think you can argue that shorts and longs in financial markets should be on equal footing, we already have that — it’s called Las Vegas!)

  26. JonW writes:

    I think your position is very valid in a cash investment. And this is why I’m harping on the difference between the synthetic vs non. In the creation of a normal CDO I would totally agree that packaging it together then selling it to someone should provide a whole different notion of “fairness.” And that’s because as the seller you assume no risk, you’re getting rid of something. In this transaction both parties have continued risk.

    In this synthetic CDO though its not quite like that, and it should be clearly understood that way. Nothing exists until the transaction. So in this case both sides are as you say basically gambling. It really truly just gambling. Normally when you create bonds, stocks or what have you, its investing in the sense that you’re providing someone capital in exchange for returns. Here there exists no capital investment whatsoever, its purely just speculative a bet.

    The true concept of investing is that you’re providing money to someone who is going to use it to build a business, buy a home, go to school etc. Here all that’s being done is people entering into agreements to try and outwit one another to make money. They are fulfilling no net capital needs anywhere in the economy.

    And that’s the core of my problem with how this has been framed. No one, neither IKB, Paulson or ACA were truly investing in the economy, or anything. They were “investing” only in the sense that they thought whatever they bought would give them returns. It’s absolutely no different than Vegas as you call it.

    The problem I have with the current discourse is that it frames the problems of the system completely wrong. The problem is the pure speculation that takes place in any market and how to combat it. From people flipping houses to speculative derivatives bets. It’s hard for anyone to argue that the $200+ oil barrel prices weren’t in large part a result of speculation.

    I would even argue that when it comes to derivatives they should favor the short side more than the long, just to prevent the creation of massive unsustainable bubbles.

    I completely agree that the financial markets should be about investing. But that’s not what much of it truly is now. A lot of it is speculative betting and if that’s the case then the shorts and the longs should play the same game.

  27. […] to mimic the experience of tranches in the notional CDO. It did so in the usual way, just as a commodity ETF or “vanilla” synthetic CDO would: The entity accepts money from investors, and uses those funds to purchase ordinary, low-risk […]

  28. […] Synthetic securities are not so strange […]

  29. […] Synthetic securities are not so strange […]

  30. My question is, “what was the pool of assets which the ‘imaginary CDS’ contracts were supposed to cover, which ABACUS was then priced to mimic tranches A-1 and A-2 of?” (if that makes any since).

    Basically, did goldman just take A-1 and A-2 level synthetic CDO yields from other offerings and then apply them to this deal, or was the price of the ABACUS deal derived upon based upon bid and ask values from IBK/ACA and Paulson? If Paulson and IBK/ACA just came to a comfortable price for an imaginary contract on AAA rated paper, then one would suppose that the value of the supposed CDS’s could be derived…

    Your thoughts?