1
Subprime Money TrailSubprime Money Trail
How subprime mortgage can end up in your investmentsHow subprime mortgage can end up in your investments
Home
buyers
Mortgage
brokers
Big banksSubprime
lenders
Securitization
manufacture of
CDOs
WALL ST
Investors
LOAN
DEBTS
CDO
Securities
/CDOs
MBS
MORTGAGE
LOANS
AAA
AA-
BBB
Rating
Rating
companies
Source: Bloomberg Markets, July 2007
2
Financial AlchemyFinancial Alchemy
1.The CDO
A CDO is a company typically incorporated
offshore that buys collateral such as bonds,
mortgage-backed securities and loans and sells
debt securities with varying degrees of risk
2.Multiply CDOs
A CDO with collateral consisting of pieces of
other CDOs is called a CDO squared. When a
CDO is built of CDO squareds, it’s called a CDO
cubed.
Unrated equity(toxic waste)
$
Interest payment
Potential losses
Bonds
Mortgage-
backed
securities
Other asset-
Backed
securities
$
SECURITIESCOLLATERAL
CDOCDO
CDOCDO
CDO squareds
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDOCDO
CDO cubeds
Wall Street has a way to transform risky debt into CDOs rated AAA or Aaa.Wall Street has a way to transform risky debt into CDOs rated AAA or Aaa.
Source: Bloomberg Markets, July 2007