CDO vs. MBS

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Feb 13, 2009 11:13 am

Not sure if anyone watched the CNBC special "House of Cards" last night, but for a newer guy trying to get my hands around the debacle that is our current fiscal situation, I thought it did a fair job explaining a simplified view of the problems we are experiencing.

 
With that said, does anyone know how the CDO worked in conjunction with the MBS? They explained that some financial engineers created a CDO as a security built of pieces of MBS's. If that is true, did they (financial engineers) really create a security collateralized twice on the same asset? I.E. - a house in FL is shown both in a MBS and in the CDO? And if so, wtf?
Feb 16, 2009 10:44 pm

I saw the show. IMO, I was expecting a little more, being the biggest debacle in the history of finance and all. Yes, greed was the underlying theme, but I still think the greatest breach of trust was at the rating agencies.



One thing is clear to me, by the time Greenspan and the FED realized that Frankenstein was alive, the damage was done. His policy of gradualism was no match for the monster we are facing. They debated whether to slam on the brakes and cause the mess we have now: historic foreclosures, spiking unemployment and a systemic breakdown in banking, but instead, he decided to exit "stage left" and brought in Bernanke. Its no coincidence that Bernanke is a scholar of the depression. We're gonna need it to avert a catastrophe here.



In answer to your question: A mortgage is a secured interest in a property. As such, an MBS is secured by an interest in the underlying property. A CDO is not secured by the property but rather by the cash flow of the borrower's mortgage payment. It is cash flow dependent. So a CDO is twice removed from the underlying home. The faster people default on their mortgage payments, the faster the value of a CDO declines.



Take a look at this video which does a good job of illustrating the dilemma:http://www.youtube.com/watch?v=ebR1-PqRrw

Feb 16, 2009 10:49 pm

http://www.youtube.com/watch?v=ebR1-PqRrw

Let me try that link again.

Feb 17, 2009 10:23 am

So, let me get this straight...a CDO is secured by something that is secured by an underlying property?

 
I guess I don't understand why anyone would buy or sell a CDO other than just to make something up to sell. I mean, if you wanted to buy a real estate related investment like that, why not just by an MBS? It seems to me (and this may be the point) that you are just asking for trouble when you have an investment that is twice removed from the actual asset.