Investors Don’t Want to Destroy Themselves With Derivatives, After All

Hey, psst. Wanna buy a synthetic CDO?

Earlier this month, we got the news that a couple of Wall Street banks were trying to drum up interest in a synthetic collateralized debt obligation, or CDO, the kind of so-called “weapon of mass destruction” that most people blame for exacerbating the financial crisis. This was good news for investors who were hungry for high-yielding assets, and bad news for the rest of humankind.

Luckily, the effort to revive the world’s most-hated financial instrument has failed, at least for now. The Financial Times reports that the synthetic CDO being shopped around by JPMorgan Chase and Morgan Stanley had trouble getting interest from investors.

JPMorgan Chase and Morgan Stanley have scrapped a plan to sell “synthetic collateralised debt obligations” – sliced and diced pools of credit derivatives – after failing to find investors willing to take on all of the deal’s different pieces … The deal would have included a range of tranches: a “senior piece” considered less risky than the “mezzanine”, or middle, piece, and the lowest-ranking “equity” tranche. Investors, though, balked at buying the top slice of the floated deal, according to people familiar with the talks. Finding the appropriate prices for these senior tranches has proved difficult since CDOs were created.

It’s like trying to line up boxcars,” said one investor.

Matt Yglesias is right that the failure of the synthetic-CDO revival is a cheering sign — even though, as I pointed out earlier this month, the market for them is being made with more caution on all sides this time around. Hedge funds and other risk-loving investors are willing to snap up the equity and mezzanine tranches of these instruments — the slices of the CDO pie that are considered the riskiest and most likely to default — but you need large institutional investors, like banks and monoline insurers like AIG, to buy up the senior, supposedly more secure slices. Those institutional investors, who have been made lawsuit- and loss-wary since 2008, are simply too scared to jump back into the pool yet.

There might be, at some point in the intermediate future, room for another synthetic CDO. (Clearly there’s interest from issuers and some risk-seeking investors.) But that point isn’t here. The fact that the boxcars won’t line up means that there are, apparently, limits to the financial sector’s risk tolerance.

CDO Nostalgia Flops