The Credit Bubble’s “Final Frontier” – Meet Goldman’s Fixed Income Global Structured Covered Obligation

Fixed Income Global Structured Covered Obligation. Say that three times fast.

According to yesterday’s Wall Street Journal, the bailed out financial criminals at Goldman Sachs are set to launch the latest and greatest toxic derivative product directly into the portfolios of willing muppets the world over. It all starts this September, so public pension funds may as well just start taking out stacks of hundreds and torching them at Burning Man while they still have a chance.

Yes, it’s called the “Fixed Income Global Structured Covered Obligation,” and no, you will not have a clue what’s in it. No seriously, you won’t have a clue.

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The Wall Street Journal describes the “final frontier in the search for yield:”

Ultra-loose monetary policy has prompted investors to take more risk in exchange for yield. For some, that means buying lower-rated bonds or debt with longer maturities. Another route is to invest in more complex deals. All this creates incentives for financial engineering. In credit derivatives markets, there are signs investors are delving back into esoteric structures. 

Citigroup reports a “large increase” in trading of products that slice and dice exposure to defaults in credit-default-swap indexes. The bank says this is mostly driven by hedge funds, but that other investors who may struggle to meet return targets could be drawn in.

Another example: Goldman Sachs has been marketing a new structure: a so-called Fixed Income Global Structured Covered Obligation that may come to market in September. It borrows elements of covered bonds, a structure with a long history in Europe. Investors will have a claim on a pool of dedicated assets and against two guarantors, Goldman and Mitsui Sumitomo Insurance.

But in many ways, the deal isn’t a covered bond. Instead of funding mortgages or public-sector loans, it will provide funding for a portfolio of fixed-income securities sourced from Goldman. The deal is structured via a derivative, a total-return swap entered into by Goldman Sachs Mitsui Marine Derivative Products.

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.

But here’s the best part…

S&P has rated the deal triple-A. 

Not to worry. As Paul Butnik informed us earlier today:

So there’s that.

Of course, this is just the latest iteration of the current credit bubble, which I’ve covered extensively this year. Some additional recent articles on the topic can be found below:

UltraLong Bond Madness – Issuance of Debt with 30 Year+ Maturity Soars 22% in 2014

Credit Bubble Update – Issuance of CLOs Expected to Hit Record in 2014

Junk Borrowers Are Increasingly “Adjusting Earnings” to More Easily Sell Debt

Credit Mania Update – The Chase for CCC-Rated Bonds Is the Credit Bubble Popping?

Carlyle Group Warns on Frothiness and Junk Bond Deals Get Pulled

Guest Post: Is There a Massive High Yield Credit Bubble?

In Liberty,
Michael Krieger

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  1. Hidden Financial Bombs: Margin Calls Hit Hedge Funds Speculating in Freddie/Fannie Bonds With High Repo Leverage

    In short, Wall Street prime brokers looking for trades and spreads offered cheap carry trade financing to the “credit” oriented hedge funds so that they could arb the GSE risk-sharing RMBS bonds based on money market interest rates that are pegged and controlled by the Fed. Needless to say, were the Fed to actually begin normalizing short-term money market rates, the recent disorder and margin calls in this market would amount to a mere Sunday School picnic. And if the current already 61 month long business cycle expansion should meet its inexorable end and roll-over into another recession, the watchword would be “look-out below!”

    Yet here’s the thing. The structured finance product calls STACRs issued by the GSEs are just a tony microcosm, and a tepid one at that, of the trillions in structured finance products that have been issued by Wall Street dealers and their counterparts around the world.

    Overwhelmingly, these products are not backed by real collateral or cash flows, but instead, are the embodiment of computerized algorithms based on reference pools of other securities—-some of these being synthetics, too.

    So the central banks have unleashed a devils work shop.

    The story below provides but a glimpse of their handiwork. When the massive tide of central bank liquidity and cheap debt finally begins to recede, there will be margin calls everywhere. And the list of exploding acronyms like STACRS will stretch on as far as the eye can see.

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