Structured Finance and Collateralized Debt Obligations: New Developments in Cash and Synthetic Securitization (Wiley Finance) [Hardcover]

I echo the praises of this book sung by previous reviewers. But I can also say in all sincerity that this is the most fun book I can ever recall reading about finance.

The book isn't an overview of the current credit crisis per se, but a detailed look at some of the building blocks that came tumbling down (as well as some that might collapse in the future, such as total-rate-of-return (TRO) swaps). It's addressed to a professional audience, so if you're shy about reading books with some equations you might not enjoy it so much. Most of these are pretty simple, though, and none involve calculus.

Still, I'd recommend that you not be put off by the quantitative bits and professional terminology. To a greater extent than most other finance books, Tavakoli uses diagrams to explain the deal structures. The pictures aren't always understandable separately from the text, but they are generally very lucid and valuable. Most importantly, interspersed with the material for practitioners are extended narrative, historical and critical passages, which will give you an insider's insights into the role human nature plays in quantitative finance. Although she's a financial professional herself, Tavakoli isn't afraid to call 'em how she sees 'em, often with a bit of appropriate cynicism, e.g. "Hedge funds have made massive leveraged credit bets, knowing that their upside is billions in fees and their downside is millions in fees" @ 430. I even laughed out loud in a couple of places, which was a personal first for a book of this genre.

Occasionally Tavakoli uses terminology that isn't explained until later (such as "value at risk" (VaR), which is mentioned @ 87 but not explained until the next chapter, @ 94ff); unfortunately, the index is an erratic aid in this situation (e.g., VaR's first entry in the index is for page 97). But these are very minor quibbles, and shouldn't discourage you from reading this terrific book.

I'm told Ms. Tavakoli is doing a booming business these days helping plaintiffs with synthetic CDO lawsuits. If so, there may be some justice in the world. She is a rare creature of finance, hard-working genius grounded in ethics that should define the profession (i.e., due diligence on behalf of clients. What a concepts). As others have rightly noted, the book contains something you can't find *anywhere* else: myriad details of real-world transactions and actual practices as they vary from theory. In short, the straight scoop from the inside.

Briefly, my only nit, which is unrelated to Ms. Tavakolio's genius and generosity: the organization and editing of the book are, at times, a bit too much brisk swerving narrative and not enough pedagogy (e.g., there isn't quite enough help understanding the synthetic CDO and equity CDO case studies, I doubt many readers will suffer the details in the way they are presented). She knows too much stuff. On some of the transactions, I struggled to keep up. A full reading of the book would have taken less time if they had polished the final, tightened the organization, and paused to explain in a few areas. She is five stars and then some, the book is four stars for degree of difficulty.

The first half of book is generally an introduction to credit derivatives, the building blocks that constitute the more sophisticated CDO technologies; e.g., CDS, CLN, role of SPE/SPV, early CDO technology, credit enhancement (very important!), CDOs backed by RMBS.

The best part of the book is the second half. Selected highlights:

* Great stuff on CDO tranches; e.g., senior tranches tend to bear the systemic risk while junior (1st to default) tranches bear the name or idiosyncratic risk
* The best part of the book, for me, is the detailed compare/contrast between a synthetic arb CDO and cash arb CDO; e.g., cash CDO has a market risk hedge counterparty (interest rate and currency), synthetic CDO does not; synthetic CDO has a super senior tranche;
* Several brilliant anecdotes related to model risk in practice (mis-applications of models). If she doesn't prove to you that "approximately right" is a better goal than "precisely wrong," nothing will budge you.
* Helpful due diligence questions for an investor to ask of CDO manager; e.g., have you been deposed in last 5 years?
* Stinging take down of Basel regulatory framework ("Basel II is part of a series of failures by various financial regulators to capture the most fundamental risk in the banking system: lending money to someone who may not pay you back"..."as securitizations began to come back on the balance sheets in 2007, it was clear that BIS had no idea of the problems that leverage, synthetics, and securitizations could pose")
* Best expose of the super senior tranche. It's unbelievable and stranger than fiction.
* Funny digs at the roles of regulators, economists and lawyers. You gotta love her. It occurs to me she may be fearless, in part, because she makes a habit of doing the right thing.
* Dense, important material about the nuances of hedging ineffectiveness; e.g., single-tranche CDO
* What does she conclude in the chapter "The Credit Crunch and CDOs?" There is no other way to say this, it's a broadside against the credit rating agencies. On several levels, by the way (motives, application of statistics). She says, "My own view is that for structured products, the NRSRO designation should be revoked." She makes the point that "savvy investors ignore ratings" (i.e., knowing they are wrong).

If you are going to buy only one book on this topic, this is the one to buy.

First, it covers all the critical aspects of structured products: quantitative, qualitative, legal, etc.

Second, it provides an insightful analysis that makes it easy to grasp the issues behind the current financial crisis [What, Why & Who]

Third, it is written by somebody who understands the topics and has done the stuff (NOT by somebody who talked to somebody who thinks is an expert, but cannot know for sure because he(or she) does not really know the topic well).

Fourth, it is written in a style that is fresh and engaging, but precise: neither the pedantic language of some academics nor the infantilizing language of some amateurish journalists.

Chapter 17 (The Credit Crunch and CDOs) is a MUST for anyone involved in the structured products market.

ARTURO CIFUENTES