ETFnerd

How UBS Lost Money on Super-Senior Bonds

Sell Everything, I don't really understand your post. Felix says in the article that UBS was buying protection, not selling it:

"these were Super Senior positions where the risk of loss was initially hedged through the purchase of protection on a proportion of the nominal position"

I am sure that UBS was in the business of selling CDS protection if they had a willing buyer to fleece, but that is not in the factset of the original article.

Also, by saying: "To make money upfront off of buying protection, one would need to write the contract with a spread under the original spread on the bond with that being the market spread, and since spreads have only be widening, that was never possible."

are you saying that negative basis trading was not possible during the 2002-2006 period when CDO desks were going full throttle? I don't think this is true.

How UBS Lost Money on Super-Senior Bonds

You view this as a failure in risk controls. I view this as an agency problem where the CDO desk traders were wolves able to clean out the UBS henhouse.

How UBS Lost Money on Super-Senior Bonds

Thomas Tan in this article:

seekingalpha.com/artic...

contends that CDS protection for super senior tranches of CDOs don't make sense. These were AAA rated and did not need credit default protection at inception. The collateralization in the structure should have been more than sufficient. In retrospect it wasn't, or maybe the current write down is due to liquidity concerns rather than risk of default. This is certainly possible.

Mr. Tan contends that the primary purpose of CDS protection was to accelerate the earnings recognition process. In negative basis trading, the purchase of the CDS would have allowed UBS to recognize the discounted NPV of the hedged earnings stream for the duration of the bond on Day 1.

If this was the purpose of the protection, then it makes perfect sense to minimize the cost and extent of the protection measure, an this would enlarge the spread that they can book. After the bonus is paid on the earnings booked, the future losses are UBS' shareholders' problem.

Most of the folks at the UBS structured products desk are probably gone, but I betcha they didn't give back any part of bonuses paid to them in their heyday.