Wharton – CDOs Are Back: Will They Lead to Another Financial Crisis?

by Sabrina I. Pacifici on April 14, 2013

Knowledge@Wharton: “Collateralized debt obligations (CDOs), the bad boys of the financial crisis of 2008, are coming back. CDOs are securities that hold different types of debt, such as mortgage-backed securities and corporate bonds, which are then sliced into varying levels of risk and sold to investors. With the Federal Reserve committed to keeping interest rates low, investors — such as pension funds seeking higher returns — are driving demand once again for these structured securities, which are riskier but provide more bang for the buck than safer bets such as Treasuries and investment-grade corporate bonds. This year, Deutsche Bank launched an $8.7 billion CDO in two tranches with payments ranging from 8% to 14.6%, garnering strong interest from investors, according to a January 24 story in Bloomberg News. In the U.S., firms such as Redwood Trust have started selling CDOs backed by commercial real estate for the first time since the credit crunch, Bloomberg reported in a January 14 article…In the last two quarters of 2012, global outstanding collateralized loan obligations, a type of CDO, surged to $384 billion after showing sequential declines since the fourth quarter of 2010, according to the Securities Industry and Financial Markets Association. “Now we’re going to see a surge in CDO issuance,” Reynolds said. “These are the same instruments that were used in the last credit boom. “It was a boom, however, that preceded the financial crisis.”

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