Separate special purpose entities—rather than portfolio123 slippage in forex 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”.
2007—when the CDO market grew to hundreds of billions of dollars—this had changed. The first CDO was issued in 1987 by bankers at now-defunct Drexel Burnham Lambert Inc. 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. Depository banks had incentive to “securitize” loans they originated—often in the form of CDO securities—because this removes the loans from their books.
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. Fears of deflation, the bursting of the dot-com bubble, a U. 2000 to 2004-5, according to Economist Mark Zandi. Gaussian copula models, introduced in 2001 by David X.
Li, allowed for the rapid pricing of CDOs. Source: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, p. Securitization markets were impaired during the crisis. The volume of CDOs issued globally crashed during the subprime crisis but has recovered slightly. Around 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. CDOs, like mortgage-backed securities, were financed with debt, enhancing their profits but also enhancing losses if the market reversed course.
The more challenging task is finding buyers for the riskier pieces of at the bottom of the pile. To deal with the problem investment bankers “recycled” the mezzanine tranches, selling them to underwriters making more structured securities—CDOs. CDOs became “the perfect dumping ground for the low-rated slices Wall Street couldn’t sell on its own. Growing demand for fixed income investments that started earlier in the decade continued. 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.