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collateralized debt obligation

collateralized debt obligations

Financial Product Largely Blamed For Crisis Was forged In A Crisis


"More than 100 securities cases involving losses of $400 billion were filed against financial firms last year, according to Cornerstone Research." - Vikas Bajaj 01/19/08

"Let's hope we are all wealthy and retired by the time this house of cards falls." - Standard & Poor analyst 'texting' about OTC CDO.


"Moral hazard" is a term commonly applied to financial contracts, under which one party is obliged to pay another money if a specified event occurs.

Moral hazard refers to situations in which the very existence of the contract alters the behavior of one party increasing the probability of the event's occurrence or the size of the monetary payoff based on that event, or both.


December 2008 A quarterly report issued by the Bank of International Settlements states the total outstanding notional amount of over-the-counter (OTC) derivatives in the world is $683 trillion while the gross market value for those same instruments was $22 trillion.

Bank like investment strategies - such as the use of leverage and financing long-term investments with short-term debt - became common outside the safety net provided by deposit insurance and strong regulation.

As a result nonbank institutions became vulnerable to runs.

If markets lost confidence their sources of funds could dry up.

Complexity reduces transparency.

"Neither regulators nor market participants can easily assess the true financial condition of firms that hold or trade these newer instruments.

Since large parts of derivatives markets are unregulated, there is a global web of financial claims and counterclaims that is essentially invisible to financial supervisors and market participants alike.

Key characteristics that produced this systemic vulnerability include:

the use of complex financial instruments, whose value is often linked by complex formulae to the value of other instruments or financial variables, and for which no active trading markets exist;

extensive use of leverage, or borrowed funds, which permits institutions to take larger market positions with a given capital base, increasing potential profits (but also losses);

and the practice of moving risky financial speculation off the books, into nominally independent accounting entities, so that the results do not appear in the financial accounts of the parent financial institution." - Mark Jickling




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