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An asset-backed securities index is a curated list of asset-backed security exposures that is used for performance bench-marking or trading.
The original asset-backed securities index was the ABX, a synthetic tradeable index sponsored by Markit (now IHT Markit), which referenced a basket of 20 subprime mortgage-backed securities.
On 17 January 2006, CDS Indexco and Markit launched ABX.HE, a subprime mortgage backed credit derivative index on home equity loans as assets, with plans to extend the index to other underlying assets, such as Credit Cards (ABX.CC), Student Loans (ABX.SL) and Auto Loans (ABX.AU). [1] In a marketing presentation [2] CDS IndexCo was described as the owner of the DJ CDX family of credit default swap (CDS) indices formed from a merger of the major CDS indices (iBoxx and Trac-X) in April 2004. It introduced a "second generation product such as index tranches and index options." [3] They launched the Home Equity (ABX.HE) ABX on 19 January 2006. Advertised daily prices were availability on the Markit website. The purpose of the indices is to allow investors to trade exposures to the subprime market without holding the actual asset backed securities. The ABX.HE Index was created from "qualifying deals of 20 of the largest sub-prime home equity ABS shelf programs from the six month period preceding the roll." [4] The market makers of ABX.HE were listed as Goldman Sachs, JPMorgan, Deutsche Bank, Barclays Capital, Bank of America, BNP Paribas, Citigroup, Credit Suisse, Lehman Brothers, Merrill Lynch, RBS Greenwich, UBS and Wachovia. [5]
These investment firms had "anticipated the crisis." In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down." [6]
Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion. According to a New York Times [6] article Goldman Sachs's trader Jonathan M. Egol created's Abacus mortgage-backed CDOs, collateralized debt obligations (CDOs), beginning in 2004, with housing prices soaring and the mortgage mania in full swing. Goldman Sachs sold them to investors, and then bet short against them. [6]
On 14 November 2007, Markit acquired International Index Company and agreed to acquire CDS IndexCo. [7]
According to a [8] New York Times article, Goldman Sachs used an ABX index to bet against (i.e. short) the housing market in 2006. It also "began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar, and Soros Fund Management." [8] [6]
On Saturday/Sunday, November 5–6, 2011 in "Prime Signs of Pain Emerge", the Wall Street Journal [9] [10] offered an extensive and literate discussion of fall of the "PrimeX Index" [11] which (to paraphrase the WSJ) focuses on "prime-mortgage bonds" that are "supposed to be of high quality". WSJ Author [9] suggested that "Prime Mortgages" are now in increasingly deep trouble which portends a collapse in the value those securities thus mirroring the earlier collapse of subprime mortgages. [9] [10] Katy [9] pointed out that just as John Paulson bet against subprime mortgages (presumably in 2006-2008), a new class of speculators and hedgers are now lining up to bet that homeowners with prime-mortgages will walk away from their houses as their values go "under water". [9]
In finance, a derivative is a contract that derives its value from the performance of an underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply called the "underlying". Derivatives can be used for a number of purposes, including insuring against price movements (hedging), increasing exposure to price movements for speculation, or getting access to otherwise hard-to-trade assets or markets. Some of the more common derivatives include forwards, futures, options, swaps, and variations of these such as synthetic collateralized debt obligations and credit default swaps. Most derivatives are traded over-the-counter (off-exchange) or on an exchange such as the Chicago Mercantile Exchange, while most insurance contracts have developed into a separate industry. In the United States, after the financial crisis of 2007–2009, there has been increased pressure to move derivatives to trade on exchanges.
A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default or other credit event. That is, the seller of the CDS insures the buyer against some reference asset defaulting. The buyer of the CDS makes a series of payments to the seller and, in exchange, may expect to receive a payoff if the asset defaults.
The Goldman Sachs Group, Inc., is an American multinational investment bank and financial services company headquartered in New York City. It offers services in investment management, securities, asset management, prime brokerage, and securities underwriting. It also provides investment banking to institutional investors.
A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS). Originally developed as instruments for the corporate debt markets, after 2002 CDOs became vehicles for refinancing mortgage-backed securities (MBS). Like other private label securities backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived from ratings on those bonds or assets.
An asset-backed security (ABS) is a security whose income payments and hence value are derived from and collateralized by a specified pool of underlying assets.
A credit default swap index is a credit derivative used to hedge credit risk or to take a position on a basket of credit entities. Unlike a credit default swap, which is an over the counter credit derivative, a credit default swap index is a completely standardized credit security and may therefore be more liquid and trade at a smaller bid–offer spread. This means that it can be cheaper to hedge a portfolio of credit default swaps or bonds with a CDS index than it would be to buy many single name CDS to achieve a similar effect. Credit-default swap indexes are benchmarks for protecting investors owning bonds against default, and traders use them to speculate on changes in credit quality.
The United States subprime mortgage crisis was a multinational financial crisis that occurred between 2007 and 2010 that contributed to the 2007–2008 global financial crisis. It was triggered by a large decline in US home prices after the collapse of a housing bubble, leading to mortgage delinquencies, foreclosures, and the devaluation of housing-related securities. Declines in residential investment preceded the Great Recession and were followed by reductions in household spending and then business investment. Spending reductions were more significant in areas with a combination of high household debt and larger housing price declines.
The subprime mortgage crisis impact timeline lists dates relevant to the creation of a United States housing bubble and the 2005 housing bubble burst and the subprime mortgage crisis which developed during 2007 and 2008. It includes United States enactment of government laws and regulations, as well as public and private actions which affected the housing industry and related banking and investment activity. It also notes details of important incidents in the United States, such as bankruptcies and takeovers, and information and statistics about relevant trends. For more information on reverberations of this crisis throughout the global financial system see Financial crisis of 2007–2008.
Markit Ltd. was a British financial information and services company with over 4,000 employees, founded in 2003 as an independent source of credit derivative pricing. The company provides independent data, trade processing of derivatives, foreign exchange and loans, customised technology platforms and managed services. The company aims to enhance transparency, reduce financial risk and improve operational efficiency. Its client base includes institutional participants in the financial marketplace. On 12 July 2016, Markit and IHS Inc. merged in an all-stock merger of equals to form IHS Markit.
The loan credit default swap index (LCDX) is a loan-only credit default swap index created by CDS Index Company (CDSIndexCo). The LCDX index is a tradeable index with 100 equally weighted underlying single-name loan-only credit default swaps (LCDS).
A synthetic CDO is a variation of a CDO that generally uses credit default swaps and other derivatives to obtain its investment goals. As such, it is a complex derivative financial security sometimes described as a bet on the performance of other mortgage products, rather than a real mortgage security. The value and payment stream of a synthetic CDO is derived not from cash assets, like mortgages or credit card payments – as in the case of a regular or "cash" CDO—but from premiums paying for credit default swap "insurance" on the possibility of default of some defined set of "reference" securities—based on cash assets. The insurance-buying "counterparties" may own the "reference" securities and be managing the risk of their default, or may be speculators who've calculated that the securities will default.
This article provides background information regarding the subprime mortgage crisis. It discusses subprime lending, foreclosures, risk types, and mechanisms through which various entities involved were affected by the crisis.
Credit rating agencies (CRAs)—firms which rate debt instruments/securities according to the debtor's ability to pay lenders back—played a significant role at various stages in the American subprime mortgage crisis of 2007–2008 that led to the great recession of 2008–2009. The new, complex securities of "structured finance" used to finance subprime mortgages could not have been sold without ratings by the "Big Three" rating agencies—Moody's Investors Service, Standard & Poor's, and Fitch Ratings. A large section of the debt securities market—many money markets and pension funds—were restricted in their bylaws to holding only the safest securities—i.e. securities the rating agencies designated "triple-A". The pools of debt the agencies gave their highest ratings to included over three trillion dollars of loans to homebuyers with bad credit and undocumented incomes through 2007. Hundreds of billions of dollars' worth of these triple-A securities were downgraded to "junk" status by 2010, and the writedowns and losses came to over half a trillion dollars. This led "to the collapse or disappearance" in 2008–09 of three major investment banks, and the federal governments buying of $700 billion of bad debt from distressed financial institutions.
Magnetar Capital is a hedge fund based in Evanston, Illinois. The firm was founded in 2005 and invests in fixed income, energy, quantitative and event-driven strategies. The firm was actively involved in the collateralized debt obligation (CDO) market during the 2006–2007 period. In some articles critical of Magnetar Capital, the firm's arbitrage strategy for CDOs is described as the "Magnetar trade".
Paulson & Co. Inc. is an American investment management firm, established by its president and portfolio manager, John Paulson in 1994. Specializing in "global merger, event arbitrage and credit strategies", the firm had a relatively low profile on Wall Street until its hugely successful bet against the subprime mortgage market in 2007.
Many factors directly and indirectly caused the Great Recession that started in 2008 with the US subprime mortgage crisis. The major causes of the initial subprime mortgage crisis and following recession include the Federal Reserve lowering the Federal funds rate and creating a flood of liquidity in the economy, international trade imbalances, and lax lending standards contributing to high levels of developed country household debt and real-estate bubbles that have since burst; U.S. government housing policies; and limited regulation of non-depository financial institutions. Once the recession began, various responses were attempted with different degrees of success. These included fiscal policies of governments; monetary policies of central banks; measures designed to help indebted consumers refinance their mortgage debt; and inconsistent approaches used by nations to bail out troubled banking industries and private bondholders, assuming private debt burdens or socializing losses.
The financial crisis of 2007–2008, also known as the global financial crisis (GFC), was a severe worldwide economic crisis. Prior to the COVID-19 recession in 2020, it was considered by many economists to have been the most serious financial crisis since the Great Depression. Excessive risk-taking by banks, combined with the bursting of the United States housing bubble, caused the values of mortgage-backed securities tied to American real estate to plummet and financial institutions to suffer significant damage globally, culminating in the bankruptcy of Lehman Brothers on September 15, 2008 and a subsequent international banking crisis. This risk-taking was explicitly incentivized by government intervention in the housing and financial markets. Massive bail-outs of financial institutions and other palliative monetary and fiscal policies were employed, ostensibly to prevent a collapse of the global financial system. The crisis sparked a global recession that resulted in increases in unemployment and suicides, decreases in fertility and general trust in institutions, and ultimately contributed to the Eurozone crisis.
Wall Street and the Financial Crisis: Anatomy of a Financial Collapse is a report on the financial crisis of 2007–2008 issued on April 13, 2011 by the United States Senate Permanent Subcommittee on Investigations. The 639-page report was issued under the chairmanship of Senators Carl Levin and Tom Coburn, and is colloquially known as the Levin-Coburn Report. After conducting "over 150 interviews and depositions, consulting with dozens of government, academic, and private sector experts" found that "the crisis was not a natural disaster, but the result of high risk, complex financial products, undisclosed conflicts of interest; and the failure of regulators, the credit rating agencies, and the market itself to rein in the excesses of Wall Street." In an interview, Senator Levin noted that "The overwhelming evidence is that those institutions deceived their clients and deceived the public, and they were aided and abetted by deferential regulators and credit ratings agencies who had conflicts of interest." By the end of their two-year investigation, the staff amassed 56 million pages of memos, documents, prospectuses and e-mails. The report, which contains 2,800 footnotes and references thousands of internal documents focused on four major areas of concern regarding the failure of the financial system: high risk mortgage lending, failure of regulators to stop such practices, inflated credit ratings, and abuses of the system by investment banks. The Report also issued several recommendations for future action regarding each of these categories.
The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History is a debut non-fiction book by American journalist Gregory Zuckerman. The book was released on November 3, 2009 by Crown Business. The book investigates the reasons and consequences of the subprime mortgage crisis and the role that hedge fund manager John Paulson played in those events.
Goldman Sachs controversies are the controversies surrounding the American multinational investment bank Goldman Sachs. The bank and its activities have generated substantial controversy and legal issues around the world and is the subject of speculation about its involvement in global finance and politics. In a widely publicized story in Rolling Stone, Matt Taibbi characterized Goldman Sachs as a "great vampire squid" sucking money instead of blood, allegedly engineering "every major market manipulation since the Great Depression."
Index Tracking Credit-Worthy Borrowers Is on the Decline; Hedge Funds Go Short