Thursday, December 6th, 2007...7:44 pm
CDOs
The Collateralized Debt Obligation was invented by some financial sharpie about twenty five years ago, but determining the value of CDOs was a bit of a problem so they did not become immediately popular. Earlier this decade some other financial sharpie developed a valuation model which became accepted as reliable and CDOs became a land office business.
Steven Pearlstein has a report in the WP today that well explains how a bunch of rich investment bankers made a bunch of money and are now losing some of it. He warns that the worst is yet to come in terms of the economic fallout from the swindle.
CDOs are bundle of debt, mortgages being the most presently relevant example, though may be composed of any type of debt.
With the coming of a valuation method the banking and investment houses began to aggressively seek debt which to bundle, divide into “tranches” of various risks and returns, and vend. Mortgages with which to create CDOs became scarcer and mortgage vendors proliferated selling mortgages to satisfy the increased demand.
Soon mortgage vendors were plumbing the “sub-prime” mortgage market (sub-prime, by the way, referring to the borrowers less than prime credit worthiness, not the interest rate), selling creatively structured mortgages (zero down, ARMs, and etc.), many of which even the originator knew could not be repaid.
Those more financially savvy saw an opportunity to buy a house at zero down, refinanced as the value rose to remove equity for consumer spending, and then walked away with their profits when the value dropped.
Another case of financial sharpies putting profits before prudence and causing economic discomfort for a good part of the world.
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1 Comment
December 29th, 2007 at 8:26 pm
[…] My condensed, and uneducated, version of how the banks and financial houses arrived at the state of requiring financial rescue may be found here. […]
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