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Invisible Zombies: The Quiet Return of Synthetic CDOs

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Mary Childs reports that synthetic CDOs are on the rise once again:

Derivatives that pool credit-default swaps to make magnified bets on corporate debt, popularized in the last credit bubble, are making a comeback as investors search farther afield for alternatives to bonds at record-low yields.

Citigroup Inc. (C) is among banks that have sold as much as $1 billion of synthetic collateralized debt obligations this year, following $2 billion in all of 2012, according to estimates from the New York-based lender. Trading in so-called tranches of indexes that use a similar strategy to juice yields rose 61 percent in the past month.

Synthetic credit, which amplified the financial crisis five years ago, is enticing investors after corporate-bond yields dropped to less than half the 20-year average. By betting on the degree to which a group of companies will default, a CDO may pay relative yields of more than 5 percentage points, four times that of a typical credit-swaps transaction on similar debt.

The thing to note about these deals is that they neatly avoid all those pesky Dodd-Frank rules about putting derivatives on exchanges. Because these are bespoke, bilateral deals, no one needs to put them through a clearing house or openly list prices.

Felix Salmon has some good commentary about this and why it should be troubling. But he's way too sanguine about the fact that for some reason not a single one of these things shows up in the database of the Securities Industry and Financial Markets Association. That's very alarming. Citigroup's head of structured credit says there were $2 billion of these things issued last year. Sifma's official count shows zero.

I'm not sure what feat of financial engineering has made these trades invisible to Sifma. But if Sifma is missing them, you can be other regulators are, too.

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