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CDOs: definitive answering..

April 15, 2010

A while back I was asked about collateralized debt obligations and, specifically, how come they had been so big in the markets..?

As with a lot of things I queued this one, keeping a look out for succinct – rather than immediate and likely wordy ā€” answers.

To hand, and today, the following from Yves Smith@nakedcapital…

CDOs were transactions that bought up low rated tranches from mortgage backed securities. Issuers and bankers of mortgage backed securities came to rely on CDOs as the buyer of the low rated MBS bonds almost exclusively by 2006. As soon as the mortgage bonds were assembled, they knew with certainty that a CDO would buy them because the purchase had been lined up, frequently with companies or units effectively controlled by the lead investment bank, even before the loans were made. The issuance of a CDO was a great money making scheme for the banks, adding further to the demand for MBS bonds, because they would finance the MBS that were intended for the upcoming CDO in warehouse lines with the CDO manager. Creating CDOs for the purpose of buying mortgage bonds was an essential part of the banker toolkit in this era.

Which effectively says how investment bank(IB) capture had gotten hold of essentially reliant entities. In its way, a market simulation of whole cities consumer capture throughout an earlier era.

The latter survives.. the formerly, deservedly, does not to anything like the uninformed extent of its initiation and growth.

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