Collateralised debt obligation

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Collateralised debt obligation — three words which taken separately seem harmless and rather nice, but when put together convoke Satan and all his hellish angels of leverage. when bundled together and sliced up, make a CDO squared which really is the stuff of nightmares.

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CDO

Bowie started it. Lehman finished it. No-one enjoyed it.

Docs Full blown 144A standalone. Hundreds of thousands of little words, and not one of them will help you. 9
Amendability The manager might make some portfolio substitutions, but who do you think that will help? 8
Collateral Ninja collateral. Literally. 7
Transferability Yeah but no. Made worse because they look so transferable. 7
Leverage Funding-wise, no. Money down up front. Risk wise? Hell yeah. 7
Fright-o-meter But the ratings! The ratings! 8

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Can be made out of credit derivatives rather than actual loans — in which case it is a synthetic CDO, or out of the junior tranches of other CDOs they could not for some reason shift off the balance sheet, in which case it is a CDO squared. Doesn’t sound like a good idea, huh? Wasn’t. This didn’t stop Rating Agencies rating them triple A!

That didn’t stop them from doing CDOs of CDO squareds, which were, of course, CDO cubed — or Rating Agencies rating them triple A.

Who would have thought, a few short months later, the entire financial system would collapse?

See also