Uncorking CDOs: How The Credit Crisis Cascades

I came across this video on the mortgage crisis... it does a better job of explaining the credit derivatives market than I did last week. I said credit derivatives are a fine idea, provided you do the math right... but they didn't do the math right... and everything fell apart. Here's how:


Crisis explainer: Uncorking CDOs from Marketplace on Vimeo.

(Hat tip Cordell)

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Where were the ratings agencies?

This is an interesting little summation of the issue. If this is accurate, it leaves one question in my mind, where were the ratings agencies? In order to sell debt that's rated AAA, AA, etc, there must have been a rating attached to it. Moody's, Fitch, somebody had to put that stamp on it. If there was in fact AAA debt being sold that was in turn backed by B grade debt, how could they have let this happen? It's there job to evaluate these types of things and establish an accurate level of risk to the debt.

Asleep at the wheel...

As I said in a previous post, the ratings agencies didn't do the math correctly. They were under a lot of pressure to "make it work," so they did a good job analyzing market risk, but failed to take into account capital risk.

You'll notice that these CDOs became popular in 2004, when they changed the bankruptcy law to not allow people to escape credit card debt. Then the credit agencies started giving everybody and his dog a credit card, and they started selling their debt as securities. These were already kind of sketchy, but relatively stable.

Then the mortgage folks got involved... but the housing market had its own problems to begin with, and you can escape mortgage debt...

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