As we said yesterday, the massive bubble resulting from central bank financial repression is hiding in plain sight in the structured finance space. All of these exotic products—like the new Freddie Mac “bonds†which amount to bottled equity risk—- are designed to produce “yield†where our Eccles Building overlords have decreed there shall be none. And even then, the going is tough. Invariably, the “return†on speculator equity is achieved by leveraging-up the freshly minted synthetic “asset†in question.
The trouble with this game is that the value of most structured finance products is opaque and subject to sharp and violent change under conditions of financial stress. So when they are “funded†in carry trade manner via repo or other prime broker hypothecation arrangements, the hedge fund gamblers who have loaded up on these newly minted structures are subject to margin calls which can spiral rapidly in a financial crisis. And that, in turn, begets position liquidation, plummeting prices for the “asset†in question, and even more liquidation in a downward spiral.
Perhaps as a signal that the bubble’s end is near, The Wall Street Journal has now debuted the ultimate in structured finance opacity. Apparently Goldman will soon be offering a new structure called “Fixed Income Global Structured Covered Obligation†(FIGSCO ?) that may come to market in September. The nifty feature for this synthetic “asset†is that the reference pool of securities on which it is based can apparently change anytime and without the approval of investors. As the WSJ described it:
And investors won’t know what exactly is in the pool. They will get a breakdown of the kinds of assets included, but not the exact composition. And what is in the structure can change. Crédit Agricole  notes the pool could be predominantly residential-mortgage backed securities at one point, sovereign debt at another and corporate bonds at yet another.
