In the paper, Credit Risk Transfer Governance: The Good, the Bad, and the Savvy, which was recently made publicly available on SSRN, I examine credit risk transfer (CRT) transactions and focus on credit default swaps (CDSs), collateralized debt obligations (CDOs), and other securitization transactions.

Governance research often focuses on the role of equityholders and directors at the institutional level. My paper, however, draws upon creditor governance scholarship and extends its insights to CRT at the transactional level. By examining CRT instruments such as CDSs and CDOs within the framework of creditor governance, it becomes possible to distinguish between good and bad CRT governance.

CRT governance consists of the transaction structures and practices that protect investors (and counterparties) against losses from the underlying credit risk being transferred. Good governance requires governance mechanisms to reduce the informational asymmetries and incentive misalignments of particular CRT transactions—the agency costs of CRT. Good CRT governance can protect investors (and counterparties) from losses even if the underlying assets whose credit risk is transferred experience significant losses. Bad CRT governance, by contrast, creates transaction structures that leave parties with highly sensitive exposures to losses in underlying credit assets. Savvy CRT transactions are those that produce gains for one side at the expense of the other because one side better understood how the governance of a particular CRT transaction should be priced, and positioned itself accordingly. Certain savvy hedge funds used synthetic CDOs to profit from the ultimate bursting of the housing bubble.

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