Gillian Tett was just in the office to talk about her new book; I interviewed her for Reuters TV, and the results should be up soon. But we got to chatting afterwards, and she made a great point which we didn’t cover in the more formal interview and which she says she would have liked to have put in her book. But since it’s not there, I can at least put it on YouTube. She talks about the Bistro deal (see Jesse for background on that), and how it can be seen as a metaphor for the financial system more generally:
The point is similar to the one I made in my speech to the regional bond dealers: we were far too worried about risk, and not nearly worried enough about safety. And really it was the insatiable demand for safety in general, and triple-A risk in particular, which caused this financial crisis.
In the typical usage, which I can’t guarantee Tett is using as I haven’t watched the video yet, it doesn’t matter what size the first loss piece is specifically. What matters is that the super senior tranche is senior to another tranche that is rated AAA. Basically You need enough subordination or other credit enhancement for AAA, and then some more. So you could have a tiny first loss piece, then a second loss, third loss and so on, provided that below the super senior piece, there’s a AAA one. Obviously, the “thicker” the AAA tranche, the sounder your super seniority – although as we all discovered, if correlations are high, it doesn’t make much difference.