re: Just finished reading 'The Big Short' - questions

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1) I don't think I completely understand the concept of 'synthetic' CDOs. The way Michael Lewis explains this it seems like you could keep repackaging CDSs that you buy on sub-prime triple B rated bonds into synthetic CDOs, the idea being you use CDSs to replicate the worst of the bonds many times over since the banks couldn't extend home loans fast enough to whet their appetite, so to speak.

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A synthetic CDO is basically a conditional collateralized debt obligation, that is to say, it's a collection of collateralized debts that are not actually debts at the time but will be if certain conditions are met.

From what I remember, the credit default swaps that were being offered by AIG and whatnot were insuring the default risk of triple A rated subprime mortgage bonds (could've been the CDOs comprised of the lesser tranches of mortgage bonds, I'm not sure). On paper, the issuers of credit default swaps were insuring against the default of bonds rated on the same level as U.S. treasury bonds. On paper, buying a credit default swap on that kind of bond would be a sucker's bet; I think the CDS payouts were triggered by a percentage of defaults within a given bond, which was considered unlikely for an investment of that grade. Thus, for the issuer of a synthetic CDO, almost everything out there was hedged on that synthetic CDO being worthless.

I'm not sure what you mean by repackaging CDSs though. Are you wondering why they didn't offer an infinite amount of synthetic CDOs to be purchased by a relatively small number of investors (at the time)?