CDOs

Today's That Settles That

Interesting thread from the Flite Line Lounge “ A synthetic CDO is a collateralised debt obligation that is based on credit default swaps rather physical debt securities. CDOs were invented by Michael Milken’s Drexel Burnham Lambert in the late 1980s as a way to bundle asset backed securities into tranches with the same rating, so that investors could focus simply on the rating rather than the issuer of the bond. True, but not quite the whole story. CDOs specifically were intended to *dilute risk* via the bundling, based on the observation that some sub-prime debt might become uncollectable, but much wouldn't. Since we don't know which borrower falls into which category (or will in the future), bundling into CDOs minimizes the risk of a given investment to a given investor. - lotp About a decade later, a team working within JP Morgan Chase invented credit default swaps, which are contractual bets between two parties about whether a third party will default on its debt. In 2000 these were made legal, and at the same time were prevented from being regulated, by the Commodity Futures Modernization Act, which specifies that products offered by banking institutions could not be regulated as futures contracts. This bill, by the way, was 11,000 pages long, was never debated by Congress and was signed into law by President Clinton a week after it was passed. It lies at the root of America’s failure to regulate the debt derivatives that are now threatening the global economy. Anyway, moving right along – some time after that an unknown bright spark within one of the investment banks came up with the idea of putting CDOs and CDSs together to create the synthetic CDO. and now you know... 3dc ” See?  Had Bill's mother aborted him, no 9/11, and no sub-prime meltdown.