Last week, when the Sheila Bair subprime-modification plan became the Hank
Paulson subprime-modification plan, I tentatively
suggested that junior bondholders might be winners, while senior bondholders
could lose out:
In reality, it’s almost certain that some bondholders would benefit from
this scheme, while others would lose out. My intuition is that the plan would
help out junior bondholders at the expense of senior bondholders, although
it probably differs on a case-by-case basis.
Waldman disagrees. He has a long post explaining his reasoning, but here’s
his conclusion:
The proposal effectively represents a transfer of wealth from junior to senior
trancheholders.
Is he right? Caroline
Baum doesn’t think so. She quotes Josh Rosner approvingly:
The way these CDO structures are set up, defaults in underlying mortgages
trip certain triggers that serve to protect senior noteholders. If the plan
inhibits defaults, "the cash flows that should be reserved for the AAA
holders will end up going to the residual owners," Rosner said.
So according to Waldman, the Pauslon plan moves money from junior to senior
trancheholders, while according to Rosner the flow is in the opposite direction.
Maybe someone at Treasury could step in and clear this issue up once and for
all?