Word: cdos
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...protecting its debt, through an instrument called a credit default swap, began to rise rapidly as investors feared that Bear would not be good for the money it promised on its bonds. Not familiar with credit default swaps? Well, we didn't know much about collateralized debt obligations (CDOs) either - until they began to undermine the economy. Credit default swaps, once an obscure financial instrument for banks and bondholders, could soon become the eye of the credit hurricane...
This time around, though, the ratings agencies didn't just fail to see a financial calamity coming. They helped cause it. Why did collateralized debt obligations (CDOs) based partly on risky subprime mortgages lead to so much trouble? Because Moody's and S&P awarded them dubiously generous letter grades. It's the same story for the mostly incomprehensible tizzy over bond insurance...
...profit machine going, Moody's and S&P have to keep finding new things to rate. And they're under intense pressure from issuers and investors alike to get as many securities as possible into the top ratings categories. The result is grade inflation, especially in new products like CDOs. That's how banks and investors around the world ended up owning billions of dollars in triple-A mortgage junk. It also helps explain the growth of bond insurers, companies that used their own triple-A ratings to bump ever more bond issues into the top categories--even as their...
...acknowledge the toxicity of the new mortgage, the broker then sells off this debt to investment banks, which collect mortgages in bulk, securitizing them as collateralized debt obligations (CDOs). These CDOs are packages of mortgage-backed bonds, securitized from pieces of mortgages. As such, they can contain varying qualities of mortgages, despite tranches—or divisions of CDOs—that are intended to rank based on risk. Rating agencies are also to blame, because they facilitate the bank’s sale of securities to institutional investors. Many funds are restricted to buying only the highest quality securities...
...music stopped for good the day Prince resigned, when Citi announced that it had $55 billion in subprime-related securities, mostly CDOs, still on the books. It also disclosed that it's holding almost $135 billion in securities for which there are no observable market prices--meaning that their valuation is determined by guesstimation--and is involved with another $167 billion in off-the-books CDOs and special investment vehicles. The normally mild-mannered stock and credit analysts who follow the firm reacted with downgrades and criticism--their main complaint being that Citi had been so slow in fessing...