Saturday, December 29, 2007

Norma: an unlucky name?

Norma, the star of Bellini's opera of the same name, winds up swimming with the fishes. Norma Desmond of Sunset Strip fame winds up in the loony bin. And Norma CDO I Ltd. is the cover girl for an inside look by the Wall Street Journal at a devastated CDO.

Norma is a CDO that started out with rating agencies assigning a AAA rating to 75% of its securities in March of this year. By November the bloom was off the rose and Norma was thrown on the junk pile.

Norma started life being 'worth' $1.5 billion. However, only a small part of Norma was real, i.e., actual securities that you could touch and feel. Most of it was made up of derivatives that acted as insurance on BBB-rated mortgage securities. These derivatives (in this case called credit-default swaps) 'insured' BBB-rated subprime bonds, but the actual bonds were worth only about a third of what they were valued at in the CDO. So that, for example, $1500 in Norma represented only $500 in real assets. Furthermore, some of the pieces of Norma were themselves slices of other CDOs.

What were they smoking?

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