General Discussion
In reply to the discussion: If you have not seen The Big Short, I seriously recommend you watch. [View all]jmowreader
(50,557 posts)The Wharton School, a very famous and very good business school, agrees.
http://knowledge.wharton.upenn.edu/article/cdos-are-back-will-they-lead-to-another-financial-crisis/
Let's talk about what a CDO is supposed to be - kind of the mutual fund of the credit derivatives trade. You know what a mutual fund is: someone who has, supposedly, great experience in investing purchases a basket of 20 to 30 stocks and sells shares of the fund. A CDO is the same thing but it's with loans and derivatives - all sorts of them. A CDO creator can buy all sorts of debt of all different kinds for the derivative he is creating - some of these monsters contain mortgage-backed securities on both residential and commercial properties, various kinds of asset-backed securities (same thing as an MBS but with non-mortgage debt), leaseholds, cash, whole mortgages...just anything you want. They then evaluate each loan in the portfolio and place it in one of five categories (slices, or "tranches" - the French word for slices) according to risk. They've been issuing exactly these CDOs since 1987 and, until Mitt Romney figured out you could build a more-balls-than-brains CDO out of subprime loans and sell it at hedge-fund-level interest rates, no one ever heard of CDOs because they weren't a problem at all.
Mitt Romney is the whole key to this mess. He needed a new funding source for his corporate raids (the old ones were breaking rocks) so he decided he could tranche the nastiest subprime crap in the world into one huge pool instead of five. He naturally needed lots of subprime to do this with and the mortgage industry was happy to oblige. And of course they needed lots of expensive houses people couldn't afford to write subprime on, so the builders cooperated. (Why the hell do you think the McMansion craze came about?) And he needed these things rated Triple-A, so the rating agencies cooperated.
No sir. If CDOs are brought back to their roots as diverse investment vehicles, tranched properly and sold to the right investors, it'll be okay.