It was just the start of the year 2007 when the bond world started to unravel its highly complicated controversies of all time. The year wasn’t even a quarter old when people started to notice the huge losses in the market of the Collateralized Debt Obligations (CDOs). That undoubtedly crushed the risky hedge funds and spread a great sense of fear amongst the fixed-income groups of people. Well, this had already marked the beginning of the credit crisis as people started looking for debt consolidation methods. It is the 2007 CDO market wherein lies the root cause of the global debt market issues. This is quite a surprising revelation as the housing market was considered to be the prime reason behind the present situation.
Collateralized Debt Obligation (CDO)
It is really surprising to know that Collateralized Debt Obligation (CDO) has managed to elude the average American for so many years despite the fact that it is mainly accountable for the economic troubles.
The year 1987 saw the creation of CDOs by the bankers at Drexel Burnham Lambert Inc. it wasn’t even a decade since their creation that the CDOs took the shape of a major force in the derivatives market. The value of other assets is used in the derivation of the value of the derivative. It is to be noted that CDOs are nowhere similar to the straightforward derivates like calls, options and credit default swaps.
The very first tremors in the world of CDO were felt by Wall Street in the year 2007. An increasing number of defaults were reported in the mortgage market. There were derivatives included in the CDOs built upon not just mortgages, but very risky and subprime mortgages as well.
There were troubles for everyone who had been big CDO buyers. They included the hedge fund managers, the pension funds and the commercial and investment banks. The core CDO assets were falling. Unfortunately, the math models that were meant to ensure the protection of the investors also stopped working. The complete absence of the markets where the CDOs could be sold made the situation even more complicated. This is because of the fact that there is no possible way of unloading CDOs unless you already had one in your portfolio. You must remember that CDOs aren’t structured for trading let alone trading them on exchanges.
The CDO managers found themselves in a similar situation. The gradual disappearance of the underlying assets of the CDO market was mainly caused by the fear that began to spread far and wide by then. There was a deadlock situation as the dumping of the swaps, subprime-mortgage derivatives and other CDO securities became suddenly impossible.
The present day credit crisis
It took another year for the CDO crisis to turn into the present day credit crisis. The collapse of the CDO market triggered the collapse of the derivative market as well. The credit-ratings agencies suffered severe damages to their reputation. They can be held partially responsible for the situation as it was their duty to foresee the dangers and warn the Wall Street accordingly. Things turned out to be a mess for the banks and brokerage houses as they tried hard to prompt an increase in their capital.
It was the March of 2008 that one of the most shocking incidents of all time happened. It was the collapse of one of Wall Street’s largest and most prestigious firms – Bear Stearns.
Eventually, the bond insurance companies had to lower their credit ratings because of the fallout. The bond market saw the birth of another credit crisis. There was a forced change in the debt rates by the state regulators. The big players in the debt market had to force a reduction in their stakes or make an early exit. The mid-2008 revealed how unsafe the situation was for everyone. The assessment of the overall damage by the auditors made it clear that everyone was accountable and is liable to pay the price irrespective of whether or not they had made any investment.