A CDO Story for the Rest of Us

The Washington Post goes long with a look at how the CDO market went bust.

I know, I know. You can’t bear to read anything else about collateralized-debt obligations. I sympathize! But it’s worth a look-see. The story clearly explains an extremely difficult to explain subject, while bringing up some interesting information.

For instance, I didn’t know this (and I’ve read a lot of CDO stories):

Sold from trusts often organized in the Cayman Islands, the bonds were listed only on the Irish Stock Exchange, of all places. An official there readily acknowledged that the exchange handled no trades in the bonds. No prices were made public, and documents on file at the exchange were available only to those who purchased the bonds.

That led to this:

The only public reporting of the deals were the gains or losses on the securities recorded by their owners. Under this system, regulators had no official window into the bigger picture — that these private securities had grown so numerous and involved so many companies that they posed a collective risk to the entire financial system.

And the reporter, Jill Drew, justifies her headline—“Frenzy”—with stuff like this:

Volume and speed dominated the process. Michael Anderson, a former mortgage trader for a Wall Street firm, said he would receive an e-mail from a mortgage originator like Washington Mutual that offered, say, a $1 billion package that included thousands of loans. Anderson had as little as an hour to bid. Some Wall Street firms, including Merrill Lynch and Bear Stearns, bought mortgage origination companies so they could cut out the bidding process and pump collateral more quickly into their CDO machines.

It would have been good to have named which Wall Street firm the trader worked for.

Meanwhile, the Post hits the regulators a bit:

The Securities and Exchange Commission, charged with overseeing the private ratings companies, did little to scrutinize their procedures during this time. In the summer of 2007, after S&P, Moody’s and Fitch began slashing their grades on CDO bonds they had once blessed, the SEC stepped in to investigate what had gone wrong. This summer, without naming names, an SEC staff report faulted the ratings firms for not doing enough to police their conflict-of-interest policies.

But it ends on a wrong note, letting a former SEC commissioner (who was there for six years during the problem period) run off about how deregulation wasn’t the problem:

Former SEC commissioner Paul S. Atkins, a strong advocate of deregulation during his six-year tenure that ended earlier this year, agreed that the trading of CDOs and other private investments must be done more openly to prevent systemic risk. But he cautioned that there needs to be smarter regulation, not just more rules.

“Remember this crisis began in regulated entities,” Atkins said, referring to investment and commercial banks overseen by the SEC and other federal agencies. “This happened right under our noses.”

The regulators weren’t regulating, though. The sniffer wasn’t sniffing. That was the Bush administration philosophy.

It’s too bad the Post this good story ended on a dishonest note from a guy who was responsible for preventing much of the stuff the Post describes.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.