[joncooper]

Comparing the LIBOR spread isn't enough to compare senior subprime tranches to senior prime tranches. Among other things, the attachment point matters a very a great deal.

The attachment point is the % of cumulative losses after which a given tranche starts suffering losses of principal. So for example:

L+20 with a 20% attachment point against historical max losses in the asset class over all credit cycles of 1% is a lot better on a risk adjusted basis than L+200 with a 40% attachment point against historical max loss experience of 15%.

Without talking about historical loss experience we can't really guesstimate the margin of safety here nor say that a given tranche is or isn't good value.

Another possibly interesting nitpick: LIBOR isn't risk-free. It's an interbank rate so it is the short-term yields paid by highly rated financial institutions. Risk free means backed by an entity that can print money, like the Fed. That's why the LIBOR-Fed Funds basis exists.

Also, re: "I think it's interesting how high interest rate risky loans can be considered as sleazy while giving opportunities to the less fortunate is considered an admirable goal." check out the book _Scarcity_ by Mullanaithan and Shafir, which has a super interesting take on this question!

[bko]

Completely agree with everything you said. I was only calling libor risk-free as it is what would be substituted for the risk free rate used in finance textbooks. Technically it's not risk-free but serves as a base return to benchmark off of. Also, most of these bonds pay coupons linked to libor.

Attachment and detachment point are definitely very important. I found a random fed document from 2012 that suggests similar attachment/detachment points for AAA prime vs subprime abs securities (~79% attachment). I haven't looked at it too closely though and I could be missing something. I know spreads are a lot tighter since 2012 and credit quality of underlying loans may have worsened with lower standards. On the other hand, people are a lot better off now that in 2012 (i.e. stock market, housing market, etc).

Will check out Scarcity. Thanks for the recommendation!

[1] http://www.federalreserve.gov/SECRS/2012/May/20120523/R-1401...

[jsprogrammer]

Current state of economic thinking: technically not risk-free, but we'll call it that anyway...what could go wrong!?

[joncooper]

Well, if you're talking about LIBOR, the risk is that the AA bank to whom you have counterparty risk will default within 3mo, so it's very, very, very low risk.