Mortgage Banking

Making sense of commercial real estate finance.

Say Goodbye to CDOs

Posted by Jordan Crouch on April 3, 2008

According to a Bank of International Settlements report, collateralised debt obligations of asset-backed securities or “CDOs of ABS” (how’s that for an acronym?!) are nearing extinction due to the current chaos in the credit market. CDOs of ABS are complex debt instruments that package the lower quality parts of asset backed bonds. Basically it is repackaging a package of loans.

To use the example from the post about Lucy, imagine we sliced Bag A and Bag B in half and put half of each in a third bag called Bag C. Lucy then sold Bag C to Carl. It’s a bit confusing but Bag C represents a CDO of ABS. The confusing part is that because it’s been sliced several times, Carl isn’t sure how much he should pay for Bag C. He’s not sure how risky this Bag C is.

What if the “fruit” we originally got from the grocery store was rotten (ie subprime loans)? By the time Carl is buying Bag C, it’s hard to tell what is rotten fruit and what isn’t. This won’t happen to Carl because the “fruit” we were using represented commercial property not residential. But Carl’s has friends who did get moldy and rotten “fruit” in their bags and he doesn’t want to end up like them. So he’s being extra careful. He might not even buy Bag C because he doesn’t want to risk it.

In a nutshell, that is what is currently happening to the credit market. No one wants to get stuck with the bag of rotten fruit.

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One Response to “Say Goodbye to CDOs”

  1. Thanks, once again for the layman’s simplification!

    Marvin Corea

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