More about CDOs

Extract from a Philips Securities Research report:

"With the ingenuity of Wall Street, investment bankers were quick to offload the risky loans into bonds called Mortgage Backed Securites (MBS) through securitization. As they found it hard to sell loans with poor credit, investment bankers sliced the bonds into smaller portion, repackaging it with much safer corporate bonds or other assets backed loans and named it Collateralized Debt Obligation (CDO). They then sold the CDOs to financial institutions and other hedge funds.

It was a challenge for rating agencies to give them credit ratings as many different loans were packaged into the MBS and CDOs. Rating agencies like S&P, Moody’s and Fitch can only use complicated mathematical models like Monte Carlo to estimate the value of the CDOs through assumptions like pre-payment rates, interest rates and default rates, and that the fair values were only as good as their mathematical assumptions.

As a result, in July alone, S&P announced 980 downgrades on MBS and placed its credit ratings on another 612 classes on RMBS backed by US subprime collateral on CreditWatch with negative implications. Moody's Investors Service cut its ratings for 399 residential mortgage-backed securities (RMBS), citing higher-than-expected delinquencies in the underlying loans."