Creditflux Newsletter

The fashion world has recently been convulsed by a controversy over “size-zero” models. Something similar has happened over the past year or so in the less glamorous world of CDOs.

Here, the concern is over those painfully thin 1% thick tranches, which, investors have discovered, are prone to keel over (at least in mark-to-market terms) at the slightest provocation.

Standard & Poor’s has addressed many failings of its CDO methodology recently, but, as Morgan Stanley points out in a recent report, S&P has done nothing to encourage more healthily curvaceous tranches.

Like the Karl Lagerfeld of the structured credit world, S&P focuses single-mindedly on attachment points, and does not worry about the survival of any poor tranches that see their loss triggers breached.

Moody’s, by contrast, has always addressed loss severity as well as loss probability. If credit structurers and raters want CSOs to come back to the financial mainstream, they should turn their backs on size-zero tranches.

One sign of irrational exuberance in the credit market is that no-one seems to find the recent dramatic rally in Dubai-related spreads at all surprising.

Apparently, everything is just fine now that Sheikh Mohammed Bin Rashid Al Maktoum has said he is “not worried” about the emirate’s ability to repay its debt.

What does the market expect him to say? “We’ve had it. We can’t afford the upkeep on the skyscrapers and have no chance of filling the office space before the city crumbles back into the sand.”