Collateralized Debt Obligations (CDOs) Explained in One Minute: Definition, Risk, Tranches, etc.
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- เผยแพร่เมื่อ 20 ส.ค. 2024
- Quite a few people who aren't necessarily economists know what Mortgage-Backed Securities are in light of the fact that after the Great Recession, they've received extensive coverage, to the point of becoming (in)famous.
But Collateralized Debt Obligations or CDOs... less so. Unfortunately, this means that people ended up having a superficial understanding of the entire mortgage debacle at best in light of the fact that if you don't know what Collateralized Debt Obligations are and how they work, you aren't even scratching the proverbial surface.
To keep it simple, think of Mortgage-Backed Securities as a specific Collateralized Debt Obligation type, where only mortgages are used, as the name suggests. When it comes to CDOs, we are therefore dealing with a broader term that encompasses a wide range of different debt types, from personal loans to corporate debt.
From definition to specifics, this video explains what CDOs are and how they work. We'll be covering the risk dimension as well, including the tranches those in movies such as The Big Short have tried to explain. Fortunately, as complicated as Collateralized Debt Obligations are, it's not that difficult to wrap your head around how things actually work... if the right economist offers to explain the process ;)
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*THE BIG SHORT*
:D
Watching it right now.
AMEN!@@senister14
That’s why I looked this up 😅
Same 😭
Quick note, as always, in light of the difficult times many of you are surely going through: first and foremost, stay safe out there and don't expose yourself unnecessarily. But since you are home, please don't waste your entire day watching Netflix and instead, pay attention to the economic dimension of what is happening as well. More specifically, think about what the economy we will be returning to will look like when all is said and done. For the foreseeable future, I will try to exclusively publish videos which help with just that (videos about the financial system, risk factors it makes sense to be aware of and so on... there is a reason why I have published a video about Mortgage-Backed Securities, followed by one about credit rating agencies, followed by one about Collateralized Debt Obligations, with one about Collateralized Loan Obligations coming on Sunday). If you are in need of assistance or simply just a sympathetic ear, I'm here for you and can be reached at andrei at one minute economics dot com :)
Thank you
Be safe and secure👍
You too, my friend, take care!
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i know it's kinda off topic but do anybody know of a good place to stream new series online?
@Duke Camilo Flixportal =)
@Ibrahim Blake thanks, I signed up and it seems like a nice service :) Appreciate it !
@Duke Camilo happy to help :)
Came here after The Big Short
Welcome aboard, would recommend also checking out my CLO video when you get a chance to (with CLOs being, according to some, the 2020 version of Mortgage-Backed Securities in terms of destructive potential): th-cam.com/video/xqnNxIcGDcw/w-d-xo.html
Watching now
First of all I love the channel and as you said I think now is a good time to try and increase my knowledge rather than wasting these months doing nothing.
I have a few questions. So Mortgage Backed Securities are a type of CDO? From watching The Big Short I thought that CDOs were often used as a way to use up all the rubbish mortgage bonds that nobody would initially buy due to their poor credit ratings. So was the main reason why CDO's had such a catastrophic impact in the financial crisis because the rating agencies gave these 'junk' mortgage bonds high ratings that they didn't warrant? Were CDO's largely used to mask worthless Mortgage bonds and get a ridiculously high rating to screw investors?
Thanks a ton for the kind words! "Greed" is the operative word, on all fronts. On the one hand, financial products without these "questionable" bonds (borderline junk) would have generated unappealingly low yields but on the other hand, sophisticated investors have to adhere by certain rules/principles and therefore cannot just invest in random ultra-risky high-yield assets. In other words, we have greedy entities (saying this in a non-judgemental way btw) that want higher returns but need proper justifications for their actions... along came credit rating agencies and voila, their greed was facilitated by the shiny scores credit rating agencies gave to these products. All of a sudden, these sophisticated investors got their "yield fix" in a manner that enabled them to justify their actions to higher-ups... after all, they bought assets considered safe by credit rating agencies. Needless to say, it's game over once the chain breaks and investors lose confidence in these assets and especially when credit rating agencies follow suit by downgrading them and generating a vicious circle. Loss of confidence -> downgrades -> even more loss of confidence, etc.
It is happening all over again what happened in 2008.But now they call the instrument ""bespoke tranche opportunity""
I'm trying to understand why the banks were willingly buying the worthless MBS's from investors who bought into them early into the start of what became the 2008 housing crash. When the collapse was imminent and investors had a limited window into unloading their worthless bonds, what incentive did the banks have by buying them when they knew they were completely worthless? Basically my question is who was left holding the bag?
Thanks for these videos! Super appreciate them!
A couple questions that came up during this time: do the investors have access to the individualized bureaus or at least credit scores of the people/companies involved in these CDOs? How much of it is based on trust of the investment bank? Does the investment bank have any incentive to not be honest with the ratings? Do the investors get paid on defaults, on successful payoff of the loans, or are there different CDOs that are based on different indexes?
Thanks a lot for the questions, Ryan.
To answer them all in one go, we'll start wit... the final one, haha. There are various different CDO types out there but the general rule as far as tranches are concerned is that the more "prudent" investors get paid first. In terms of incentives, the situation is extremely tricky because in my opinion, we are oftentimes in what one would call a moral hazard situation. As such, I'd recommend checking out two videos of mine, the moral hazard one and the video about credit rating agencies:
th-cam.com/video/0mq4-fNCbhY/w-d-xo.html
th-cam.com/video/goT1TWjqOnA/w-d-xo.html
One Minute Economics thank you I appreciate it!
And while discussing these ratings and tranches... who tells the investors that the "AAA" loan is really an "AAA" loan.
Would recommend checking out my video about credit rating agencies when you get a chance to: th-cam.com/video/goT1TWjqOnA/w-d-xo.html
@@OneMinuteEconomics just fkn answer the damn question btch
@@jaylovestesla1099 He did. Didn't he ??
Its Credit rating agencies doing the work
We are seeing this in the game industry. But i don’t know what it would be called.
Lots of high risk elements that are given low risk investment despite being very high risk.
So basically we issue out securities for a asset backed loan and depending on the rating certain investors take on the risk or not which is why some people are denied loans due to the packaging of the asset back securities either too low or too high for the investors risk tolerance 🤔🤔
thank you for explaining this so clearly
Thank YOU for taking the time to add positivity to this video by saying something nice :)
awesome video!
Thank you! :)
If you invest on this and people dont pay their loans what happens to your money? You just get it eventually but it takes more time if you are a junior investor or you could potentially lose your money?
It all depends on the tranche. If you opted for the option with the least impressive returns but best placement, you'll be first in line to get paid, whereas the most aggressive investors who wanted to maximize returns will be last in line but there are never 100% guarantees unfortunately, not even for the more prudent investors.
Why are CDOs considered dogshit wrapped in catshit in The Big Short movie??
Well, as represented in that movie: let's say a mortgage bond was dogs**t that didn't sell but they took a bunch of them and created a nice package (CDO) and once it was large enough, rating agencies rewarded them for diversifying and gave that package a very high rating. As such, they gave ultra-high ratings to... well, dogs**t wrapped in cats**t :)
One Minute Economics Thank you so much😘
I'm here because I need to write an essay on how the financial crisis from 2008 to 2009 began lol
Very interesting topic, be sure to also check out my video about Mortgage-Backed securities and my Great Recession one at the very least, probably also the Moral Hazard video. Good luck :)
I know I'm 3 years late, but the big short and margin call are really great places to begin.
Does the CDOs are effected by interest rates when the Fed raise them ?
Thank you so much!
Thank YOU for the support Luize :)
What is CDO? How investement banks introduced this in 2008 crisis? Why investement banks buy loans from banks in 2008 to produce 2008?
Prime minister
I'm not a native speaker and I feel so hard to understand what you said :((
Sorry 'bout that. Maybe the playback speed reduction tool will help, I sometimes get carried away speed-wise :(
CDO's
Synthetic CDOs lmfao
:P
The hierarchical organisational chart confused me why are mezzanine tranches subordinate to junior tranches?
Sorry for the confusion, it was meant to get the idea across that mezzanine tranches are somewhere in-between :)
@@OneMinuteEconomics No apology necessary I was far more enlightened than confused, thank you.
Didn't understand anything
Sorry to hear that, feel free to ask if there's anything specific you'd like me to clarify and I'll do my best :)
@@OneMinuteEconomics How investement banks made money through CDO?
Simple:
Step 1) Banks lend money to people and sell those loans to investment banks (not just mortgages like with Mortgage-Backed Securities but also a wide range of other debt such as credit card debt, corporate loans, etc.)
Step 2) Investment banks package a bunch of those loans together and create Collateralized Debt Obligations, which they sell to various investors
Simply put, investment banks make money by selling the various CDOs they create to other investors. But them from banks at low enough prices, package them nicely, sell to investors for more. Rinse and repeat :)
@@OneMinuteEconomics so the final risk is on the investors. How banks and investement banks failed?
@@OneMinuteEconomics and investement banks are taking money from investors so investement banks need to repay them and give them interest also.
I Didnt Understand Shit
Batch D zindabad 🏃🏃🏃🥳
Sir, nothing is hard to understand IF you have a good teacher so with that said because YOU think its hard to understand and say so then YOUR not a goid teacher for others! bye
Poorly explained and confusing!
If you'd like to, let me know what you found confusing and I will do my best to help