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A collateralized debt obligation (CDO) is a type of structured asset-backed security (ABS).

[1]
 Originally developed as instruments for the corporate debt markets, after 2002 CDOs became
vehicles for refinancing mortgage-backed securities (MBS).[2][3] Like other private label securities
backed by assets, a CDO can be thought of as a promise to pay investors in a prescribed sequence,
based on the cash flow the CDO collects from the pool of bonds or other assets it owns.
[4]
 Distinctively, CDO credit risk is typically assessed based on a probability of default (PD) derived
from ratings on those bonds or assets.[5]
The CDO is "sliced" into sections known as "tranches", which "catch" the cash flow of interest and
principal payments in sequence based on seniority. [6] If some loans default and the cash collected by
the CDO is insufficient to pay all of its investors, those in the lowest, most "junior" tranches suffer
losses first.[7] The last to lose payment from default are the safest, most senior tranches.
Consequently, coupon payments (and interest rates) vary by tranche with the safest/most senior
tranches receiving the lowest rates and the lowest tranches receiving the highest rates to
compensate for higher default risk. As an example, a CDO might issue the following tranches in
order of safeness: Senior AAA (sometimes known as "super senior"); Junior AAA; AA; A; BBB;
Residual.[8]
Separate special purpose entities—rather than the parent investment bank—issue the CDOs and
pay interest to investors. As CDOs developed, some sponsors repackaged tranches into yet another
iteration, known as "CDO-Squared", "CDOs of CDOs" or "synthetic CDOs".[8]
In the early 2000s, the debt underpinning CDOs was generally diversified, [9] but by 2006–2007—
when the CDO market grew to hundreds of billions of dollars—this had changed. CDO collateral
became dominated by high risk (BBB or A) tranches recycled from other asset-backed securities,
whose assets were usually subprime mortgages.[10] These CDOs have been called "the engine that
powered the mortgage supply chain" for subprime mortgages, [11] and are credited with giving lenders
greater incentive to make subprime loans,[12] leading to the 2007-2009 subprime mortgage crisis.[13]

Market history[edit]
Beginnings[edit]
In 1970, the US government-backed mortgage guarantor Ginnie Mae created the first MBS
(mortgage-backed security), based on FHA and VA mortgages. It guaranteed these MBSs.[14] This
would be the precursor to CDOs that would be created two decades later. In 1971, Freddie
Mac issued its first Mortgage Participation Certificate . This was the first mortgage-backed
security made of ordinary mortgages.[15] All through the 1970s, private companies began mortgage
asset securitization by creating private mortgage pools. [16]
In 1974, the Equal Credit Opportunity Act in the United States imposed heavy sanctions for financial
institutions found guilty of discrimination on the basis of race, color, religion, national origin, sex,
marital status, or age[17] This led to a more open policy of giving loans (sometimes subprime) by
banks, guaranteed in most cases by Fannie Mae and Freddie Mac. In 1977, the Community
Reinvestment Act was enacted to address historical discrimination in lending, such as 'redlining'.
The Act encouraged commercial banks and savings associations (Savings and loan banks) to meet
the needs of borrowers in all segments of their communities, including low- and moderate-income
neighborhoods (who might earlier have been thought of as too risky for home loans). [18][19]
In 1977, the investment bank Salomon Brothers created a "private label" MBS (mortgage backed
security)—one that did not involve government-sponsored enterprise (GSE) mortgages. However, it
failed in the marketplace.[20] Subsequently, Lewis Ranieri (Salomon) and Larry Fink (First Boston)
invented the idea of securitization; different mortgages were pooled together and this pool was then
sliced into tranches, each of which was then sold separately to different investors. [21] Many of these
tranches were in turn bundled together, earning them the name CDO (Collateralized debt obligation).
[22]

The first CDOs to be issued by a private bank were seen in 1987 by the bankers at the now-
defunct Drexel Burnham Lambert Inc. for the also now-defunct Imperial Savings Association.
[23]
 During the 1990s the collateral of CDOs was generally corporate and emerging market bonds and
bank loans.[24] After 1998 "multi-sector" CDOs were developed by Prudential Securities, [25] but CDOs
remained fairly obscure until after 2000.[26] In 2002 and 2003 CDOs had a setback when rating
agencies "were forced to downgrade hundreds" of the securities, [27] but sales of CDOs grew—from
$69 billion in 2000 to around $500 billion in 2006. [28] From 2004 through 2007, $1.4 trillion worth of
CDOs were issued.[29]
Early CDOs were diversified, and might include everything from aircraft lease-equipment debt,
manufactured housing loans, to student loans and credit card debt. The diversification of borrowers
in these "multisector CDOs" was a selling point, as it meant that if there was a downturn in one
industry like aircraft manufacturing and their loans defaulted, other industries like manufactured
housing might be unaffected.[30] Another selling point was that CDOs offered returns that were
sometimes 2-3 percentage points higher than corporate bonds with the same credit rating. [30][31]
Explanations for growth[edit]

 Advantages of securitization – Depository banks had incentive to "securitize" loans

they originated—often in the form of CDO securities—because this removes the loans
from their books. The transfer of these loans (along with related risk) to security-buying
investors in return for cash frees up the banks' capital. This enabled them to remain in
compliance with capital requirement laws while lending again and generating additional
origination fees.
 Global demand for fixed income investments – From 2000 to 2007, worldwide fixed
income investment (i.e. investments in bonds and other conservative securities) roughly
doubled in size to $70 trillion, yet the supply of relatively safe, income generating
investments had not grown as fast, which bid up bond prices and drove down interest
rates.[32][33] Investment banks on Wall Street answered this demand with financial
innovation such as the mortgage-backed security (MBS) and collateralized debt
obligation (CDO), which were assigned safe ratings by the credit rating agencies. [33]
 Low interest rates – Fears of deflation, the bursting of the dot-com bubble, a U.S.
recession, and the U.S. trade deficit kept interest rates low globally from 2000 to 2004–5,
according to Economist Mark Zandi.[34] The low yield of the safe US Treasury
bonds created demand by global investors for subprime mortgage-backed CDOs with
their relatively high-yields but credit ratings as high as the Treasuries. This search for
yield by global investors caused many to purchase CDOs, though they lived to regret
trusting the credit rating agencies' ratings.[35]
 Pricing models – Gaussian copula models, introduced in 2001 by David X. Li, allowed
for the rapid pricing of CDOs.[36][37]
Subprime mortgage boom[edit]
Source: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the
United States, p.128, figure 8.1
IMF Diagram of CDO and RMBS

Securitization markets were impaired during the crisis.

The volume of CDOs issued globally crashed during the subprime crisis but has recovered slightly. (source:
SIFMA, Statistics, Structured Finance[38]

Main article: Subprime mortgage crisis

See also: Subprime lending and Bear Stearns subprime mortgage hedge fund crisis
In 2005, as the CDO market continued to grow, subprime mortgages began to replace the diversified
consumer loans as collateral. By 2004, mortgage-backed securities accounted for more than half of
the collateral in CDOs.[11][39][40][41][42][43] According to the Financial Crisis Inquiry Report, "the CDO became
the engine that powered the mortgage supply chain", [11] promoting an increase in demand for
mortgage-backed securities without which lenders would have "had less reason to push so hard to
make" non-prime loans.[12] CDOs not only bought crucial tranches of subprime mortgage-backed
securities, they provided cash for the initial funding of the securities. [11] Between 2003 and 2007, Wall
Street issued almost $700 billion in CDOs that included mortgage-backed securities as collateral.
[11]
 Despite this loss of diversification, CDO tranches were given the same proportion of high ratings
by rating agencies[44] on the grounds that mortgages were diversified by region and so
"uncorrelated"[45]—though those ratings were lowered after mortgage holders began to default. [46][47]
The rise of "ratings arbitrage"—i.e., pooling low-rated tranches to make CDOs—helped push sales
of CDOs to about $500 billion in 2006,[28] with a global CDO market of over US$1.5 trillion. [48] CDO
was the fastest-growing sector of the structured finance market between 2003 and 2006; the number
of CDO tranches issued in 2006 (9,278) was almost twice the number of tranches issued in 2005
(4,706).[49]
CDOs, like mortgage-backed securities, were financed with debt, enhancing their profits but also
enhancing losses if the market reversed course.[50]
Explanations for growth[edit]
Subprime mortgages had been financed by mortgage-backed securities (MBS). Like CDOs, MBSs
were structured into tranches, but issuers of the securities had difficulty selling the more lower
level/lower-rated "mezzanine" tranches—the tranches rated somewhere from AA to BB.
Because most traditional mortgage investors are risk-averse, either because of the restrictions of
their investment charters or business practices, they are interested in buying the higher-rated
segments of the loan stack; as a result, those slices are easiest to sell. The more challenging task is
finding buyers for the riskier pieces at the bottom of the pile. The way mortgage securities are
structured, if you cannot find buyers for the lower-rated slices, the rest of the pool cannot be sold. [51][52]
To deal with the problem, investment bankers "recycled" the mezzanine tranches, selling them to
underwriters making more structured securities—CDOs. Though the pool that made up the CDO
collateral might be overwhelmingly mezzanine tranches, most of the tranches (70 [53] to 80%[54][55]) of
the CDO were rated not BBB, A−, etc., but triple A. The minority of the tranches that were
mezzanine were often bought up by other CDOs, concentrating the lower rated tranches still further.
(See the chart on "The Theory of How the Financial System Created AAA-rated Assets out of
Subprime Mortgages".)
As one journalist (Gretchen Morgenson) put it, CDOs became "the perfect dumping ground for the
low-rated slices Wall Street couldn't sell on its own." [51]
Other factors explaining the popularity of CDOs include:

 Growing demand for fixed income investments that started earlier in the decade
continued.[32][33] A "global savings glut"[56] leading to "large capital inflows" from abroad
helped finance the housing boom, keeping down US mortgage rates, even after
the Federal Reserve Bank had raised interest rates to cool off the economy.[57]
 Supply generated by "hefty" fees the CDO industry earned. According to "one hedge
fund manager who became a big investor in CDOs", as much "as 40 to 50 percent" of
the cash flow generated by the assets in a CDO went to "pay the bankers, the CDO
manager, the rating agencies, and others who took out fees." [27] Rating agencies in
particular—whose high ratings of the CDO tranches were crucial to the industry and who
were paid by CDO issuers —earned extraordinary profits. Moody's Investors Service,
one of the two biggest rating agencies, could earn "as much as $250,000 to rate a
mortgage pool with $350 million in assets, versus the $50,000 in fees generated when
rating a municipal bond of a similar size." In 2006, revenues from Moody's structured
finance division "accounted for fully 44%" of all Moody's sales.[58][59] Moody's operating
margins were "consistently over 50%, making it one of the most profitable companies in
existence"—more profitable in terms of margins than Exxon Mobil or Microsoft.
[60]
 Between the time Moody's was spun off as a public company and February 2007, its
stock rose 340%.[60][61]
 Trust in rating agencies. CDO managers "didn't always have to disclose what the
securities contained" because the contents of the CDO were subject to change. But this
lack of transparency did not affect demand for the securities. Investors "weren't so much
buying a security. They were buying a triple-A rating," according to business
journalists Bethany McLean and Joe Nocera.[27]
 Financial innovations, such as credit default swaps and synthetic CDO. Credit default
swaps provided insurance to investors against the possibility of losses in the value of
tranches from default in exchange for premium-like payments, making CDOs appear "to
be virtually risk-free" to investors.[62] Synthetic CDOs were cheaper and easier to create
than original "cash" CDOs. Synthetics "referenced" cash CDOs, replacing interest
payments from MBS tranches with premium-like payments from credit default swaps.
Rather than providing funding for housing, synthetic CDO-buying investors were in effect
providing insurance against mortgage default. [63] If the CDO did not perform per
contractual requirements, one counterparty (typically a large investment bank or hedge
fund) had to pay another.[64] As underwriting standards deteriorated and the housing
market became saturated, subprime mortgages became less abundant. Synthetic CDOs
began to fill in for the original cash CDOs. Because more than one—in fact numerous—
synthetics could be made to reference the same original, the amount of money that
moved among market participants increased dramatically.
Crash[edit]
More than half of the highest-rated (Aaa) CDOs were "impaired" (losing principal or downgraded to junk status),
compared to a small fraction of similarly rated Subprime and Alt-A mortgage-backed securities. (source:
Financial Crisis Inquiry Report[65])

In the summer of 2006, the Case–Shiller index of house prices peaked.[66] In California, home prices
had more than doubled since 2000[67] and median house prices in Los Angeles had risen to ten times
the median annual income. To entice those with low and moderate income to sign up for
mortgages, down payments and income documentation were often dispensed with and interest and
principal payments were often deferred upon request.[68] Journalist Michael Lewis gave as an
example of unsustainable underwriting practices a loan in Bakersfield, California, where "a Mexican
strawberry picker with an income of $14,000 and no English was lent every penny he needed to buy
a house of $724,000".[68] As two-year "teaser" mortgage rates—common with those that made home
purchases like this possible—expired, mortgage payments skyrocketed. Refinancing to lower
mortgage payment was no longer available since it depended on rising home prices. [69] Mezzanine
tranches started to lose value in 2007; by mid year AA tranches were worth only 70 cents on the
dollar. By October triple-A tranches had started to fall. [70] Regional diversification notwithstanding, the
mortgage backed securities turned out to be highly correlated. [24]
Big CDO arrangers like Citigroup, Merrill Lynch and UBS experienced some of the biggest losses, as
did financial guaranteers such as AIG, Ambac, MBIA.[24]
An early indicator of the crisis came in July 2007 when rating agencies made unprecedented mass
downgrades of mortgage-related securities [71] (by the end of 2008 91% of CDO securities were
downgraded[72]), and two highly leveraged Bear Stearns hedge funds holding MBSs and CDOs
collapsed. Investors were informed by Bear Stearns that they would get little if any of their money
back.[73][74]
In October and November the CEOs of Merrill Lynch and Citigroup resigned after reporting
multibillion-dollar losses and CDO downgrades.[75][76][77] As the global market for CDOs dried up[78][79] the
new issue pipeline for CDOs slowed significantly, [80] and what CDO issuance there was usually in the
form of collateralized loan obligations backed by middle-market or leveraged bank loans, rather than
home mortgage ABS.[81] The CDO collapse hurt mortgage credit available to homeowners since the
bigger MBS market depended on CDO purchases of mezzanine tranches. [82][83]
While non-prime mortgage defaults affected all securities backed by mortgages, CDOs were
especially hard hit. More than half—$300 billion worth—of tranches issued in 2005, 2006, and 2007
rated most safe (triple-A) by rating agencies, were either downgraded to junk status or lost principal
by 2009.[65] In comparison, only small fractions of triple-A tranches of Alt-A or subprime mortgage-
backed securities suffered the same fate. (See the Impaired Securities chart.)
Collateralized debt obligations also made up over half ($542 billion) of the nearly trillion dollars in
losses suffered by financial institutions from 2007 to early 2009. [46]
Criticism[edit]
Prior to the crisis, a few academics, analysts and investors such as Warren Buffett (who famously
disparaged CDOs and other derivatives as "financial weapons of mass destruction, carrying dangers
that, while now latent, are potentially lethal" [84]), and the IMF's former chief economist Raghuram
Rajan[85] warned that rather than reducing risk through diversification, CDOs and other derivatives
spread risk and uncertainty about the value of the underlying assets more widely. [citation needed]
During and after the crisis, criticism of the CDO market was more vocal. According to the radio
documentary "Giant Pool of Money", it was the strong demand for MBS and CDO that drove down
home lending standards. Mortgages were needed for collateral and by approximately 2003, the
supply of mortgages originated at traditional lending standards had been exhausted. [33]
The head of banking supervision and regulation at the Federal Reserve, Patrick Parkinson, termed
"the whole concept of ABS CDOs", an "abomination". [24]
In December 2007, journalists Carrick Mollenkamp and Serena Ng wrote of a CDO called Norma
created by Merrill Lynch at the behest of Illinois hedge fund, Magnetar. It was a tailor-made bet on
subprime mortgages that went "too far." Janet Tavakoli, a Chicago consultant who specializes in
CDOs, said Norma "is a tangled hairball of risk." When it came to market in March 2007, "any savvy
investor would have thrown this...in the trash bin."[86][87]
According to journalists Bethany McLean and Joe Nocera, no securities became "more pervasive –
or [did] more damage than collateralized debt obligations" to create the Great Recession.[26]
Gretchen Morgenson described the securities as "a sort of secret refuse heap for toxic mortgages
[that] created even more demand for bad loans from wanton lenders."
CDOs prolonged the mania, vastly amplifying the losses that investors would suffer and ballooning
the amounts of taxpayer money that would be required to rescue companies like Citigroup and the
American International Group." ...[88]
In the first quarter of 2008 alone, credit rating agencies announced 4,485 downgrades of CDOs.[81] At
least some analysts complained the agencies over-relied on computer models with imprecise inputs,
failed to account adequately for large risks (like a nationwide collapse of housing values), and
assumed the risk of the low rated tranches that made up CDOs would be diluted when in fact the
mortgage risks were highly correlated, and when one mortgage defaulted, many did, affected by the
same financial events.[46][89]
They were strongly criticized by economist Joseph Stiglitz, among others. Stiglitz considered the
agencies "one of the key culprits" of the crisis that "performed that alchemy that converted the
securities from F-rated to A-rated. The banks could not have done what they did without the
complicity of the ratings agencies." [90][91] According to Morgenson, the agencies had pretended to
transform "dross into gold."[58]
"As usual, the ratings agencies were chronically behind on developments in the financial markets
and they could barely keep up with the new instruments springing from the brains of Wall Street's
rocket scientists. Fitch, Moody's, and S&P paid their analysts far less than the big brokerage firms
did and, not surprisingly wound up employing people who were often looking to befriend,
accommodate, and impress the Wall Street clients in hopes of getting hired by them for a multiple
increase in pay. ... Their [the rating agencies] failure to recognize that mortgage underwriting
standards had decayed or to account for the possibility that real estate prices could decline
completely undermined the ratings agencies' models and undercut their ability to estimate losses
that these securities might generate." [92]
Michael Lewis also pronounced the transformation of BBB tranches into 80% triple A CDOs as
"dishonest", "artificial" and the result of "fat fees" paid to rating agencies by Goldman Sachs and
other Wall Street firms.[93] However, if the collateral had been sufficient, those ratings would have
been correct, according to the FDIC.
Synthetic CDOs were criticized in particular, because of the difficulties to judge (and price) the risk
inherent in that kind of securities correctly. That adverse effect roots in the pooling and tranching
activities on every level of the derivation. [6]
Others pointed out the risk of undoing the connection between borrowers and lenders—removing the
lender's incentive to only pick borrowers who were creditworthy—inherent in all securitization. [94][95]
[96]
 According to economist Mark Zandi: "As shaky mortgages were combined, diluting any problems
into a larger pool, the incentive for responsibility was undermined."[35]
Zandi and others also criticized lack of regulation. "Finance companies weren't subject to the same
regulatory oversight as banks. Taxpayers weren't on the hook if they went belly up [pre-crisis], only
their shareholders and other creditors were. Finance companies thus had little to discourage them
from growing as aggressively as possible, even if that meant lowering or winking at traditional
lending standards."[35]

Concept, structures, varieties[edit]

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Concept[edit]
CDOs vary in structure and underlying assets, but the basic principle is the same. A CDO is a type
of asset-backed security. To create a CDO, a corporate entity is constructed to hold assets
as collateral backing packages of cash flows which are sold to investors.[97] A sequence in
constructing a CDO is:

 A special purpose entity (SPE) is designed/constructed to acquire a portfolio of

underlying assets. Common underlying assets held may include mortgage-backed
securities, commercial real estate bonds and corporate loans.
 The SPE issues bonds to investors in exchange for cash, which are used to purchase
the portfolio of underlying assets. Like other ABS private label securities, the bonds are
not uniform but issued in layers called tranches, each with different risk characteristics.
Senior tranches are paid from the cash flows from the underlying assets before the junior
tranches and equity tranches. Losses are first borne by the equity tranches, next by the
junior tranches, and finally by the senior tranches. [98]
A common analogy compares the cash flow from the CDO's portfolio of securities (say mortgage
payments from mortgage-backed bonds) to water flowing into cups of the investors where senior
tranches were filled first and overflowing cash flowed to junior tranches, then equity tranches. If a
large portion of the mortgages enter default, there is insufficient cash flow to fill all these cups and
equity tranche investors face the losses first.
The risk and return for a CDO investor depends both on how the tranches are defined, and on the
underlying assets. In particular, the investment depends on the assumptions and methods used to
define the risk and return of the tranches.[99] CDOs, like all asset-backed securities, enable the
originators of the underlying assets to pass credit risk to another institution or to individual investors.
Thus investors must understand how the risk for CDOs is calculated.
The issuer of the CDO, typically an investment bank, earns a commission at the time of issue and
earns management fees during the life of the CDO. The ability to earn substantial fees from
originating CDOs, coupled with the absence of any residual liability, skews the incentives of
originators in favor of loan volume rather than loan quality.
In some cases, the assets held by one CDO consisted entirely of equity layer tranches issued by
other CDOs. This explains why some CDOs became entirely worthless, as the equity layer tranches
were paid last in the sequence and there was not sufficient cash flow from the underlying subprime
mortgages (many of which defaulted) to trickle down to the equity layers.
Ultimately the challenge is in accurately quantifying the risk and return characteristics of these
constructs. Since the introduction of David Li's 2001 model, there have been material advances in
techniques that more accurately model dynamics for these complex securities. [100]
Structures[edit]
CDO refers to several different types of products. The primary classifications are as follows:
Source of funds—cash flow vs. market value

 Cash flow CDOs pay interest and principal to tranche holders using the cash flows
produced by the CDO's assets. Cash flow CDOs focus primarily on managing the credit
quality of the underlying portfolio.
 Market value CDOs attempt to enhance investor returns through the more frequent
trading and profitable sale of collateral assets. The CDO asset manager seeks to realize
capital gains on the assets in the CDO's portfolio. There is greater focus on the changes
in market value of the CDO's assets. Market value CDOs are longer-established, but
less common than cash flow CDOs.
Motivation—arbitrage vs. balance sheet

Arbitrage transactions (cash flow and market value) attempt to capture for equity
investors the spread between the relatively high yielding assets and the lower yielding
liabilities represented by the rated bonds. The majority, 86%, of CDOs are arbitrage-
motivated.[101]
 Balance sheet transactions, by contrast, are primarily motivated by the issuing
institutions' desire to remove loans and other assets from their balance sheets, to reduce
their regulatory capital requirements and improve their return on risk capital. A bank may
wish to offload the credit risk to reduce its balance sheet's credit risk.
Funding—cash vs. synthetic

 Cash CDOs involve a portfolio of cash assets, such as loans, corporate bonds, asset-

backed securities or mortgage-backed securities. Ownership of the assets is transferred
to the legal entity (known as a special purpose vehicle) issuing the CDO's tranches. The
risk of loss on the assets is divided among tranches in reverse order of seniority. Cash
CDO issuance exceeded $400 billion in 2006.
  Synthetic CDOs do not own cash assets like bonds or loans. Instead, synthetic
CDOs gain credit exposure to a portfolio of fixed income assets without owning those
assets through the use of credit default swaps, a derivatives instrument. (Under such a
swap, the credit protection seller, the Synthetic CDO, receives periodic cash payments,
called premiums, in exchange for agreeing to assume the risk of loss on a specific asset
in the event that asset experiences a default or other credit event.) Like a cash CDO, the
risk of loss on the Synthetic CDO's portfolio is divided into tranches. Losses will first
affect the equity tranche, next the junior tranches, and finally the senior tranche. Each
tranche receives a periodic payment (the swap premium), with the junior tranches
offering higher premiums.
o A synthetic CDO tranche may be either funded or unfunded. Under the swap
agreements, the CDO could have to pay up to a certain amount of money in
the event of a credit event on the reference obligations in the CDO's
reference portfolio. Some of this credit exposure is funded at the time of
investment by the investors in funded tranches. Typically, the junior tranches
that face the greatest risk of experiencing a loss have to fund at closing. Until
a credit event occurs, the proceeds provided by the funded tranches are
often invested in high-quality, liquid assets or placed in a GIC (Guaranteed
Investment Contract) account that offers a return that is a few basis points
below LIBOR. The return from these investments plus the premium from the
swap counterparty provide the cash flow stream to pay interest to the funded
tranches. When a credit event occurs and a payout to the swap counterparty
is required, the required payment is made from the GIC or reserve account
that holds the liquid investments. In contrast, senior tranches are usually
unfunded as the risk of loss is much lower. Unlike a cash CDO, investors in
a senior tranche receive periodic payments but do not place any capital in
the CDO when entering into the investment. Instead, the investors retain
continuing funding exposure and may have to make a payment to the CDO
in the event the portfolio's losses reach the senior tranche. Funded synthetic
issuance exceeded $80 billion in 2006. From an issuance perspective,
synthetic CDOs take less time to create. Cash assets do not have to be
purchased and managed, and the CDO's tranches can be precisely
structured.
 Hybrid CDOs have a portfolio including both cash assets—like cash CDOs—and swaps
that give the CDO credit exposure to additional assets—like a synthetic CDO. A portion
of the proceeds from the funded tranches is invested in cash assets and the remainder is
held in reserve to cover payments that may be required under the credit default swaps.
The CDO receives payments from three sources: the return from the cash assets, the
GIC or reserve account investments, and the CDO premiums.
Single-tranche CDOs
The flexibility of credit default swaps is used to construct Single Tranche CDOs (bespoke
tranche CDOs) where the entire CDO is structured specifically for a single or small group of
investors, and the remaining tranches are never sold but held by the dealer based on
valuations from internal models. Residual risk is delta-hedged by the dealer.
Structured Operating Companies
Unlike CDOs, which are terminating structures that typically wind-down or refinance at the
end of their financing term, Structured Operating Companies are permanently capitalized
variants of CDOs, with an active management team and infrastructure. They often issue term
notes, commercial paper, and/or auction rate securities, depending upon the structural and
portfolio characteristics of the company. Credit Derivative Products Companies (CDPC)
and Structured Investment Vehicles (SIV) are examples, with CDPC taking risk synthetically
and SIV with predominantly 'cash' exposure.
Taxation[edit]
The issuer of a CDO—usually a special purpose entity—is typically a corporation
established outside the United States to avoid being subject to U.S. federal income taxation
on its global income. These corporations must restrict their activities to avoid U.S. tax
liabilities; corporations that are deemed to engage in trade or business in the U.S. will be
subject to federal taxation.[102] Foreign corporations that only invest in and hold portfolios of
U.S. stock and debt securities are not. Investing, unlike trading or dealing, is not considered
to be a trade or business, regardless of its volume or frequency. [103]
In addition, a safe harbor protects CDO issuers that do trade actively in securities, even
though trading in securities technically is a business, provided the issuer's activities do not
cause it to be viewed as a dealer in securities or engaged in a banking, lending or similar
businesses.[104]
CDOs are generally taxable as debt instruments except for the most junior class of CDOs
which are treated as equity and are subject to special rules (such as PFIC and CFC
reporting). The PFIC and CFC reporting is very complex and requires a specialized
accountant to perform these calculations and manage the tax reporting obligations.
Types[edit]
A) Based on the underlying asset:

 Collateralized loan obligations (CLOs): CDOs backed primarily by leveraged

bank loans.
 Collateralized bond obligations (CBOs): CDOs backed primarily by
leveraged fixed income securities.
 Collateralized synthetic obligations (CSOs): CDOs backed primarily by credit
derivatives.
 Structured finance CDOs (SFCDOs): CDOs backed primarily by structured
products (such as asset-backed securities and mortgage-backed securities). [105]
B) Other types of CDOs by assets/collateral include:

 Commercial Real Estate CDOs (CRE CDOs): backed primarily by commercial

real estate assets
 Collateralized bond obligations (CBOs): CDOs backed primarily by corporate
bonds
 Collateralized Insurance Obligations (CIOs): backed by insurance or, more
usually, reinsurance contracts
 CDO-Squared: CDOs backed primarily by the tranches issued by other CDOs.
[105]

 CDO^n: Generic term for CDO3 (CDO cubed) and higher, where the CDO is
backed by other CDOs/CDO2/CDO3. These are particularly difficult vehicles to
model because of the possible repetition of exposures in the underlying CDO.
Types of collateral[edit]
The collateral for cash CDOs include:

 Structured finance securities (mortgage-backed securities, home equity asset-

backed securities, commercial mortgage-backed securities)
 Leveraged loans
 Corporate bonds
  Real estate investment trust (REIT) debt
 Commercial real estate mortgage debt (including whole loans, B notes, and
Mezzanine debt)
 Emerging-market sovereign debt
 Project finance debt
 Trust Preferred securities
Transaction participants[edit]
Participants in a CDO transaction include investors, the underwriter, the asset manager, the
trustee and collateral administrator, accountants and attorneys. Beginning in 1999,
the Gramm-Leach-Bliley Act allowed banks to also participate.
Investors[edit]
Investors—buyers of CDO—include insurance companies, mutual fund companies, unit
trusts, investment trusts, commercial banks, investment banks, pension
fund managers, private banking organizations, other CDOs and structured investment
vehicles. Investors have different motivations for purchasing CDO securities depending on
which tranche they select. At the more senior levels of debt, investors are able to obtain
better yields than those that are available on more traditional securities (e.g., corporate
bonds) of a similar rating. In some cases, investors utilize leverage and hope to profit from
the excess of the spread offered by the senior tranche and their cost of borrowing. This is
true because senior tranches pay a spread above LIBOR despite their AAA-ratings.
Investors also benefit from the diversification of the CDO portfolio, the expertise of the asset
manager, and the credit support built into the transaction. Investors include banks and
insurance companies as well as investment funds.
Junior tranche investors achieve a leveraged, non-recourse investment in the underlying
diversified collateral portfolio. Mezzanine notes and equity notes offer yields that are not
available in most other fixed income securities. Investors include hedge funds, banks, and
wealthy individuals.
Underwriter[edit]
The underwriter of a CDO is typically an investment bank, and acts as the structurer and
arranger. Working with the asset management firm that selects the CDO's portfolio, the
underwriter structures debt and equity tranches. This includes selecting the debt-to-equity
ratio, sizing each tranche, establishing coverage and collateral quality tests, and working
with the credit rating agencies to gain the desired ratings for each debt tranche.
The key economic consideration for an underwriter that is considering bringing a new deal to
market is whether the transaction can offer a sufficient return to the equity noteholders.
Such a determination requires estimating the after-default return offered by the portfolio of
debt securities and comparing it to the cost of funding the CDO's rated notes. The excess
spread must be large enough to offer the potential of attractive IRRs to the equityholders.
Other underwriter responsibilities include working with a law firm and creating the special
purpose legal vehicle (typically a trust incorporated in the Cayman Islands) that will
purchase the assets and issue the CDO's tranches. In addition, the underwriter will work
with the asset manager to determine the post-closing trading restrictions that will be
included in the CDO's transaction documents and other files.
The final step is to price the CDO (i.e., set the coupons for each debt tranche) and place the
tranches with investors. The priority in placement is finding investors for the risky equity
tranche and junior debt tranches (A, BBB, etc.) of the CDO. It is common for the asset
manager to retain a piece of the equity tranche. In addition, the underwriter was generally
expected to provide some type of secondary market liquidity for the CDO, especially its
more senior tranches.
According to Thomson Financial, the top underwriters before September 2008 were Bear
Stearns, Merrill Lynch, Wachovia, Citigroup, Deutsche Bank, and Bank of America
Securities.[106] CDOs are more profitable for underwriters than conventional bond
underwriting because of the complexity involved. The underwriter is paid a fee when the
CDO is issued.
The asset manager[edit]
The asset manager plays a key role in each CDO transaction, even after the CDO is issued.
An experienced manager is critical in both the construction and maintenance of the CDO's
portfolio. The manager can maintain the credit quality of a CDO's portfolio through trades as
well as maximize recovery rates when defaults on the underlying assets occur.
In theory, the asset manager should add value in the manner outlined below, although in
practice, this did not occur during the credit bubble of the mid-2000s (decade). In addition, it
is now understood that the structural flaw in all asset-backed securities (originators profit
from loan volume not loan quality) make the roles of subsequent participants peripheral to
the quality of the investment.
The asset manager's role begins in the months before a CDO is issued, a bank usually
provides financing to the manager to purchase some of the collateral assets for the
forthcoming CDO. This process is called warehousing.
Even by the issuance date, the asset manager often will not have completed the
construction of the CDO's portfolio. A "ramp-up" period following issuance during which the
remaining assets are purchased can extend for several months after the CDO is issued. For
this reason, some senior CDO notes are structured as delayed drawdown notes, allowing
the asset manager to draw down cash from investors as collateral purchases are made.
When a transaction is fully ramped, its initial portfolio of credits has been selected by the
asset manager.
However, the asset manager's role continues even after the ramp-up period ends, albeit in a
less active role. During the CDO's "reinvestment period", which usually extends several
years past the issuance date of the CDO, the asset manager is authorized to reinvest
principal proceeds by purchasing additional debt securities. Within the confines of the
trading restrictions specified in the CDO's transaction documents, the asset manager can
also make trades to maintain the credit quality of the CDO's portfolio. The manager also has
a role in the redemption of a CDO's notes by auction call.
There are approximately 300 asset managers in the marketplace. CDO asset managers, as
with other asset managers, can be more or less active depending on the personality and
prospectus of the CDO. Asset managers make money by virtue of the senior fee (which is
paid before any of the CDO investors are paid) and subordinated fee as well as any equity
investment the manager has in the CDO, making CDOs a lucrative business for asset
managers. These fees, together with underwriting fees, administration—approx 1.5 – 2% —
by virtue of capital structure are provided by the equity investment, by virtue of reduced cash
flow.
See also: List of CDO Managers
The trustee and collateral administrator[edit]
The trustee holds title to the assets of the CDO for the benefit of the "noteholders" (i.e., the
investors). In the CDO market, the trustee also typically serves as collateral administrator. In
this role, the collateral administrator produces and distributes noteholder reports, performs
various compliance tests regarding the composition and liquidity of the asset portfolios in
addition to constructing and executing the priority of payment waterfall models. [107] In contrast
to the asset manager, there are relatively few trustees in the marketplace. The following
institutions offer trustee services in the CDO marketplace:

 Bank of New York Mellon (note: the Bank of New York Mellon acquired the
corporate trust unit of JP Morgan),
 BNP Paribas Securities Services (note: currently serves the European market
only)
 Citibank
 Deutsche Bank
 Equity Trust
 Intertrust Group (note: until mid-2009 was known as Fortis Intertrust; Acquired
ATC Capital Markets in 2013)
 HSBC
 Sanne Trust
 State Street Corporation
 US Bank (note: US Bank acquired the corporate trust unit of Wachovia in 2008
and Bank of America in September 2011, which had previously acquired LaSalle
Bank in 2010, and is the current market share leader)
 Wells Fargo
 Wilmington Trust: Wilmington shut down their business in early 2009.
Accountants[edit]
The underwriter typically will hire an accounting firm to perform due diligence on the CDO's
portfolio of debt securities. This entails verifying certain attributes, such as credit rating and
coupon/spread, of each collateral security. Source documents or public sources will typically
be used to tie-out the collateral pool information. In addition, the accountants typically
calculate certain collateral tests and determine whether the portfolio is in compliance with
such tests.
The firm may also perform a cash flow tie-out in which the transaction's waterfall is modeled
per the priority of payments set forth in the transaction documents. The yield and weighted
average life of the bonds or equity notes being issued is then calculated based on the
modeling assumptions provided by the underwriter. On each payment date, an accounting
firm may work with the trustee to verify the distributions that are scheduled to be made to
the noteholders.
Attorneys[edit]
Attorneys ensure compliance with applicable securities law and negotiate and draft the
transaction documents. Attorneys will also draft an offering document or prospectus the
purpose of which is to satisfy statutory requirements to disclose certain information to
investors. This will be circulated to investors. It is common for multiple counsels to be
involved in a single deal because of the number of parties to a single CDO from asset
management firms to underwriters.

In popular media[edit]
In the 2015 biographical film The Big Short, CDOs of mortgage-backed securities are
described metaphorically as "dog shit wrapped in cat shit". [108]
See also[edit]
 Asset-backed security
 Bespoke portfolio (CDO)
 Collateralized mortgage obligation (CMO)
 Collateralized fund obligation (CFO)
 Collateralized loan obligation (CLO)
 List of CDO managers
 Credit default swap
 Single-tranche CDO
 Synthetic CDO
 Great Recession
o United States housing bubble
o Subprime mortgage crisis
o Financial crisis of 2007–2008

References[edit]
1. ^
An "asset-backed security" is sometimes used as an umbrella term for a type of
security backed by a pool of assets—including collateralized debt obligations
and mortgage-backed securities. Example: "A capital market in which asset-backed
securities are issued and traded is composed of three main categories: ABS, MBS
and CDOs" (italics added). Source: Vink, Dennis (August 2007).  "ABS, MBS and
CDO compared: an empirical analysis"  (PDF). Munich Personal RePEc Archive.
Retrieved 13 July  2013..

Other times it is used for a particular type of that security—one backed by consumer
loans. Example: "As a rule of thumb, securitization issues backed by mortgages are
called MBS, and securitization issues backed by debt obligations are called CDO,
[and s]ecuritization issues backed by consumer-backed products—car loans,
consumer loans and credit cards, among others—are called ABS ..." (italics added).
Source: Vink, Dennis (August 2007).  "ABS, MBS and CDO compared: an empirical
analysis"  (PDF). Munich Personal RePEc Archive. Retrieved 13 July  2013.

See also: "What are Asset-Backed Securities?". SIFMA. Retrieved  13

July  2013. Asset-backed securities, called ABS, are bonds or notes backed by
financial assets. Typically the assets consist of receivables other than mortgage
loans, such as credit card receivables, auto loans, manufactured-housing contracts
and home-equity loans.

2. ^ Lepke, Lins and Pi card, Mortgage-Backed Securities, §5:15 (Thomson West,

2014).
3. ^ Cordell, Larry (May 2012). "COLLATERAL DAMAGE: SIZING AND ASSESSING
THE SUBPRIME CDO CRISIS"  (PDF).
4. ^ Azad, C. "Collateralized debt obligations (CDO)". www.investopedia.com.
Investopedia. Retrieved  31 January 2018.
5. ^ Kiff, John (November 2004). "CDO rating methodology: Some thoughts on model
risk and its implications"  (PDF).
6. ^ Jump up to:a b Koehler, Christian (31 May 2011). "The Relationship between the
Complexity of Financial Derivatives and Systemic Risk".  Working Paper:
17.  SSRN 2511541.
7. ^ Azad, C. "How CDOs work".  www.investinganswers.com. Investing answers.
Retrieved 31 January  2018.
8. ^ Jump up to:a b Lemke, Lins and Smith, Regulation of Investment
Companies (Matthew Bender, 2014 ed.).
9. ^ McLean, Bethany and Joe Nocera, All the Devils Are Here, the Hidden History of
the Financial Crisis, Portfolio, Penguin, 2010, p. 120.
10. ^ Final Report of the National Commission on the Causes of the Financial and
Economic Crisis in the United States, aka The Financial Crisis Inquiry Report, p.127
11. ^ Jump up to:a b c d e The Financial Crisis Inquiry Report, 2011, p. 130.
12. ^ Jump up to:a b The Financial Crisis Inquiry Report, 2011, p. 133.
13. ^ Lewis, Michael (2010). The Big Short: Inside the Doomsday Machine. England:
Penguin Books. ISBN 9781846142574.
14. ^ McClean, Nocera, p. 7.
15. ^ History of Freddie Mac.
16. ^ "Asset Securitization Comptroller's Handbook"  (PDF). US Comptroller of the
Currency Administrator of National Banks. November 1997. Archived from the
original  (PDF)  on 2008-12-18.
17. ^ Regulation B, Equal Credit Opportunity 12 CFR 202.14(b) as stated in Closing the
Gap: A Guide to Equal Opportunity Lending[permanent dead link], Federal Reserve System of
Boston.
18. ^ Text of Housing and Community Development Act of 1977—title Viii (Community
Reinvestment) Archived 2008-09-16 at the Wayback Machine.
19. ^ "Community Reinvestment Act". Federal Reserve. Retrieved 2008-10-05.
20. ^ McClean, Nocera, p. 12.
21. ^ McClean, Nocera, p. 5.
22. ^ Liar's Poker, Michael Lewis.
23. ^ Cresci, Gregory. "Merrill, Citigroup Record CDO Fees Earned in Top Growth
Market". August 30, 2005. Bloomberg L.P. Retrieved 11 July  2013.
24. ^ Jump up to:a b c d The Financial Crisis Inquiry Report, 2011, p. 129.
25. ^ The Financial Crisis Inquiry Report, 2011, pp. 129-30.
26. ^ Jump up to:a b Bethany McLean; Joe Nocera (30 August 2011). All the Devils Are
Here: The Hidden History of the Financial Crisis. Penguin Publishing Group.
p. 120.  ISBN  978-1-101-55105-9.
27. ^ Jump up to:a b c McLean and Nocera, All the Devils Are Here, 2010 p. 121.
28. ^ Jump up to:a b McLean and Nocera, All the Devils Are Here, 2010 p. 123.
29. ^ Morgenson, Gretchen; Joshua Rosner (2011). Reckless Endangerment  : How
Outsized ambition, Greed and Corruption Led to Economic Armageddon. New York:
Times Books, Henry Holt and Company. p. 283.  ISBN  9781429965774.
30. ^ Jump up to:a b Morgenson and Rosner Reckless Endangerment, 2010 pp. 279-280.
31. ^ McLean and Nocera, All the Devils Are Here, 2010 p. 189.
32. ^ Jump up to:a b Public Radio International. April 5, 2009. "This American Life": Giant
Pool of Money wins Peabody Archived 2010-04-15 at the Wayback Machine
33. ^ Jump up to:a b c d "The Giant Pool of Money". This American Life. Episode 355.
Chicago IL, USA. May 9, 2008. NPR.  CPM.  transcript.
34. ^ of Moody's Analytics.
35. ^ Jump up to:a b c Zandi, Mark (2009). Financial Shock. FT Press.  ISBN  978-0-13-
701663-1.
36. ^ Hsu, Steve (2005-09-12).  "Information Processing: Gaussian copula and credit
derivatives". Infoproc.blogspot.com. Retrieved  2013-01-03.
37. ^ How a Formula Ignited Market That Burned Some Big Investors| Mark
Whitehouse| Wall Street Journal| September 12, 2005.
38. ^ "SIFMA, Statistics, Structured Finance, Global CDO Issuance and Outstanding
(xls) - quarterly data from 2000 to Q2 2013 (issuance), 1990 - Q1 2013
(outstanding)". Securities Industry and Financial Markets Association. Archived
from  the original on 2016-11-21. Retrieved 2013-07-10.
39. ^ One study based on a sample of 735 CDO deals originated between 1999 and
2007, found the percentage of CDO assets made up of lower level tranches from
non-prime mortgage-backed securities (nonprime means subprime and other less-
than-prime mortgages, mainly Alt-A mortgages) grew from 5% to 36%
(source: "Anna Katherine Barnett-Hart The Story of the CDO Market Meltdown: An
Empirical Analysis-March 2009"  (PDF).).
40. ^ Other sources give an even higher proportion. In the fall of 2005 Gene Park, an
executive at AIG Financial Products division found, "The percentage of subprime
securities in the CDOs wasn't 10 percent – it was 85 percent!" (source: McLean and
Nocera, All the Devils Are Here, 2010, p. 201.
41. ^ An email by Park to his superior is also quoted in the Financial Crisis Inquiry
Report p.201: "The CDO of the ABS market ... is currently at a state where deals are
almost totally reliant on subprime/nonprime mortgage residential mortgage
collateral."
42. ^ Still another source (The Big Short, Michael Lewis, p.71) says:
"The 'consumer loans' piles that Wall Street firms, led by Goldman Sachs, asked
AIG FP to insure went from being 2% subprime mortgages to being 95% subprime
mortgages. In a matter of months, AIG-FP, in effect, bought $50 billion in triple-B-
rated subprime mortgage bonds by insuring them against default. And yet no one
said anything about it ...".
43. ^ In 2007, 47% of CDOs were backed by structured products, such as mortgages;
45% of CDOs were backed by loans, and only less than 10% of CDOs were backed
by fixed income securities. (source: Securitization rankings of bookrunners, issuers,
etc. Archived 2007-09-29 at the Wayback Machine.
44. ^ "Moody's and S&P to bestow[ed] triple-A ratings on roughly 80% of every CDO."
(source: The Big Short, Michael Lewis, pp. 207-208).
45. ^ The Big Short, Michael Lewis, pp. 207–208.
46. ^ Jump up to:a b c Anna Katherine Barnett-Hart The Story of the CDO Market
Meltdown: An Empirical Analysis-March 2009-Cited by Michael Lewis in The Big
Short.
47. ^ "SEC Broadens CDO Probes". June 15th, 2011. Global Economic Intersection. 15
June 2011. Retrieved  8 February  2014. [Includes] graph and table from Pro Publica
[that] show the size and institutional reach of the Magnetar CDOs [versus the whole
CDO market].
48. ^ "Collateralized Debt Obligations Market" (Press release). Celent. 2005-10-31.
Archived from  the original on 2009-03-03. Retrieved 2009-02-23.
49. ^ Benmelech, Efraim; Jennifer Dlugosz (2009). "The Credit Rating
Crisis"  (PDF).  NBER Macroeconomics Annual 2009. National Bureau of Economic
Research, NBER Macroeconomics Annual.
50. ^ The Financial Crisis Inquiry Report, 2011, p. 134, section="Leverage is inherent in
CDOs".
51. ^ Jump up to:a b Morgenson and Rosner Reckless Endangerment, 2010, p. 278.
52. ^ see also Financial Crisis Inquiry Report, p. 127.
53. ^ 70%. "Firms bought mortgage-backed bonds with the very highest yields they
could find and reassembled them into new CDOs. The original bonds ... could be
lower-rated securities that once reassembled into a new CDO would wind up with as
much as 70% of the tranches rated triple-A. Ratings arbitrage, Wall Street called this
practice. A more accurate term would have been ratings laundering." (source:
McLean and Nocera, All the Devils Are Here, 2010 p. 122).
54. ^ 80%. "Approximately 80% of these CDO tranches would be rated triple-A despite
the fact that they generally comprised the lower-rated tranches of mortgage-backed
securities. (source: The Financial Crisis Inquiry Report, 2011, p. 127.
55. ^ 80%. "In a CDO you gathered a 100 different mortgage bonds—usually the
riskiest lower floors of the original tower ... They bear a lower credit rating triple-B. ...
if you could somehow get them rerated as triple-A, thereby lowering their perceived
risk, however dishonestly and artificially. This is what Goldman Sachs had cleverly
done. It was absurd. The 100 buildings occupied the same floodplain; in the event of
 flood, the ground floors of all of them were equally exposed. But never mind: the
rating agencies, who were paid fat fees by Goldman Sachs and other Wall Street
firms for each deal they rated, pronounced 80% of the new tower of debt triple-A."
(source: Michael Lewis, The Big Short  : Inside the Doomsday Machine WW Norton
and Co, 2010, p. 73).
56. ^ The Financial Crisis Inquiry Report, 2011, p. 103.
57. ^ The Financial Crisis Inquiry Report, 2011, p. 104.
58. ^ Jump up to:a b Morgenson and Rosner Reckless Endangerment, 2010 p. 280.
59. ^ see also: Bloomberg-Flawed Credit Ratings Reap Profits as Regulators Fail
Investors-April 2009.
60. ^ Jump up to:a b McLean and Nocera, All the Devils Are Here, p. 124.
61. ^ PBS-Credit and Credibility-December 2008.
62. ^ The Financial Crisis Inquiry Report, 2011, p. 132.
63. ^ "Unlike the traditional cash CDO, synthetic CDOs contained no actual tranches of
mortgage-backed securities ... in the place of real mortgage assets, these CDOs
contained credit default swaps and did not finance a single home purchase."
(source: The Financial Crisis Inquiry Report, 2011, p. 142).
64. ^ "The Magnetar Trade: How One Hedge Fund Helped Keep the Bubble Going
(Single Page)-April 2010". Archived from  the original on 2010-04-10.
Retrieved 2017-10-05.
65. ^ Jump up to:a b Final Report of the National Commission on the Causes of the
Financial and Economic Crisis in the United States, p. 229, figure 11.4.
66. ^ The Big Short, Michael Lewis, p. 95.
67. ^ The Financial Crisis Inquiry Report, 2011, p. 87, figure 6.2.
68. ^ Jump up to:a b Michael Lewis, The Big Short, p. 94-7.
69. ^ Lewis, Michael, The Big Short.
70. ^ "CDOh no! (see "Subprime performance" chart)". The Economist. 8 November
2007.
71. ^ By the first quarter of 2008, rating agencies announced 4,485 downgrades of
CDOs. source: Aubin, Dena (2008-04-09). "CDO deals resurface but down 90 pct in
Q1-report".  Reuters.
72. ^ The Financial Crisis Inquiry Report, 2011, p. 148.
73. ^ "Bear Stearns Tells Fund Investors 'No Value Left' (Update3)". Bloomberg. 2007-
07-18.
74. ^ Many CDOs are marked to market and thus experienced substantial write-
downs as their market value collapsed during the subprime crisis, with banks writing
down the value of their CDO holdings mainly in the 2007-2008 period.
75. ^ Eavis, Peter (2007-10-24). "Merrill's $3.4 billion balance sheet bomb".  CNN.
Retrieved 2010-04-30.
76. ^ "Herd's head trampled". The Economist. 2007-10-30.
77. ^ "Citigroup chief executive resigns". BBC News. 2007-11-05. Retrieved 2010-04-
30.
78. ^ "Merrill sells assets seized from hedge funds".  CNN. June 20, 2007.
Retrieved May 24,  2010.
79. ^ "Timeline: Sub-prime losses". BBC. May 19, 2008. Retrieved May 24,  2010.
80. ^ "Archived copy"  (PDF). Archived from the original  (PDF) on 2008-09-09.
Retrieved 2008-03-22.
81. ^ Jump up to:a b Aubin, Dena (2008-04-09).  "CDO deals resurface but down 90 pct
in Q1-report". Reuters.
82. ^ nearly USD 1 trillion in mortgage bonds in 2006 alone.
83. ^ McLean, Bethany (2007-03-19). "The dangers of investing in subprime
debt".  Fortune.
84. ^ "Warren Buffett on Derivatives"  (PDF). Following are edited excerpts from the
Berkshire Hathaway annual report for 2002. fintools.com.
85. ^ Raghu Rajan analyses subprime crisis| Mostly Economics| (from a speech given
on December 17, 2007)
 86. ^ Wall Street Wizardry Amplified Risk, Wall Street Journal, December 27, 2007.
87. ^ Ng, Serena, and Mollenkamp, Carrick. "A Fund Behind Astronomical Losses,"
(Magnetar) Wall Street Journal, January 14, 2008.
88. ^ Morgenson, Gretchen; Joshua Rosner (2011). Reckless Endangerment  : How
Outsized ambition, Greed and Corruption Led to Economic Armageddon. New York:
Times Books, Henry Holt and Company. p. 278.  ISBN  9781429965774.
89. ^ The Financial Crisis Inquiry Report, 2011, pp. 118-121.
90. ^ Bloomberg-Smith-Bringing Down Ratings Let Loose Subprime Scourge.
91. ^ Bloomberg-Smith-Race to Bottom at Rating Agencies Secured Subprime Boom,
Bust.
92. ^ Morgenson and Rosner, Reckless Endangerment, 2010 pp. 280-281.
93. ^ Lewis, Michael (2010). The Big Short  : Inside the Doomsday Machine. W.W.
Norton & Company. p.  73. ISBN 978-0-393-07223-5.
94. ^ All the Devils Are Here, MacLean and Nocera, p. 19.
95. ^ Mortgage lending using securitization is sometimes referred to as the originate-to-
distribute approach, in contrast to the traditional originate-to-hold approach. (The
Financial Crisis Inquiry Report, 2011, p. 89).
96. ^ Koehler, Christian (31 May 2011). "The Relationship between the Complexity of
Financial Derivatives and Systemic Risk". Working Paper: 42. SSRN  2511541.
97. ^ Koehler, Christian (31 May 2011). "The Relationship between the Complexity of
Financial Derivatives and Systemic Risk". Working Paper: 12–13.  SSRN 2511541.
98. ^ Koehler, Christian (31 May 2011). "The Relationship between the Complexity of
Financial Derivatives and Systemic Risk". Working Paper: 13. SSRN  2511541.
99. ^ Koehler, Christian. "The Relationship between the Complexity of Financial
Derivatives and Systemic Risk".  Working Paper: 19.  SSRN 2511541.
100. ^ Levy, Amnon; Yahalom, Tomer; Kaplin, Andrew (2010). "Modeling
Correlation of Structured Instruments in a Portfolio Setting".  Encyclopedia of
Quantitative Finance, John Wiley & Sons: 1220–1226.
101. ^ "Archived copy"  (PDF). Archived from the original  (PDF) on 2007-09-28.
Retrieved 2007-06-29.
102. ^ PEASLEE, JAMES M. & DAVID Z. NIRENBERG. FEDERAL INCOME TAXATION OF
SECURITIZATION TRANSACTIONS AND RELATED TOPICS. Frank J. Fabozzi Associates
(2011, with periodic supplements, www.securitizationtax.com): 1018.
103. ^ Peaslee & Nirenberg. Federal Income Taxation of Securitization
Transactions, 1023.
104. ^ Peaslee & Nirenberg. Federal Income Taxation of Securitization
Transactions, 1026.
105. ^ Jump up to:a b Paddy Hirsch (October 3, 2008). Crisis explainer: Uncorking
CDOs. American Public Media. Archived from  the original on May 27, 2013.
Retrieved October 21, 2012.
106. ^ Dealbook (2 January 2008). "Citi and Merrill Top Underwriting League
Tables". January 2, 2008. New York Times. Retrieved 16 July  2013.
107. ^ Two notable exceptions to this are Virtus Partners and Wilmington Trust
Conduit Services, a subsidiary of Wilmington Trust, which offer collateral
administration services, but are not trustee banks.
108. ^ Adam McKay (Director) (November 12, 2015).  The Big Short (Motion
picture). United States: Paramount Pictures (distributor). 33 minutes in.  So
mortgage bonds are dog shit. CDOs are dog shit wrapped in cat shit?" "Yeah, that's
right.

External links[edit]
 Global Pool of Money (NPR radio)
 The Story of the CDO Market Meltdown: An Empirical Analysis-Anna Katherine
Barnett-Hart-March 2009-Cited by Michael Lewis in "The Big Short"
  Diagram and Explanation of CDO
 CDO and RMBS Diagram-FCIC and IMF
 "Investment Landfill"
 Portfolio.com explains what CDOs are in an easy-to-understand multimedia
graphic
 The Making of a Mortgage CDO multimedia graphic from The Wall Street
Journal
 JPRI Occasional Paper No. 37, October 2007. Risk vs Uncertainty: The Cause
of the Current Financial Crisis By Marshall Auerback
 How credit cards become asset-backed bonds. From Marketplace
 Vink, Dennis and Thibeault, André (2008). "ABS, MBS and CDO Compared: An
Empirical Analysis", Journal of Structured Finance
 "A tsunami of hope or terror?", Alan Kohler, Nov 19, 2008.
 "The Warning" – an episode on PBS that discusses some of the causes of
the financial crisis of 2007–2008 including the CDOs market

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Categories: 
 Bond market
 Derivatives (finance)
 Fixed-income securities
 Mortgage-backed security
 Structured finance
 Financial law
 United States housing bubble