Developments in Collateralized Debt Obligations: New ... (ISBN 0470135549)

too optimistic:
The aggregation of various types of debt (credit card, mortgage etc) and the subsequent creation of tranches of obligations is the subject of the book. Here, the real estate origination of debt is not restricted to residential instances. One chapter describes how instruments can also be made out of commercial real estate. Intrinsically similar. Though of course the risk profiles can be expected to differ from a batch of homeowners. Speaking of risk, the book has in several places extensive discussions of risk. As in the possibility of downgrades of CDOs, including the severity of these downgrades. An optimistic note is struck by "Market value CDOs really should never be downgraded." That particular section of the text goes on to explain why. In retrospect, though the book was written just a few months ago, it was far too optimistic. The downgraded examples were perhaps simply too early. As we go into 2008, there is every expectation that further deterioration will occur in many CDO fields. Maybe one should not fault the authors (too much). When they wrote this book, the analysis was plausible based on the actual performances of CDOs to date. It is just that these performances were too skimpy in duration. But there is a deeper problem with the book. In all the to do about how CDOs can spread risk, there is no deep questioning whether the process by which they were made created new risk in the first place. The companies (banks and mortgage firms) that made CDOs now had less incentive to scrutinise the borrowers' ability to repay. Because the typical case was that the CDOs were then sold to other parties, who then bore most or all of the risk. While the originators plucked lucrative fees for their roles. All the more so if some of the originators were not the firms that made the initial loans to borrowers, but financial firms that devised the CDO structures.

Optimistic?:
This is one of the authors of the book, called "optimistic" by one of its reviewers. I'd like to thank that reviewer for taking the time to make many thoughtful comments. I'd also like to clarify that the specific example of over optimism given by the reviewer is not the best. The comment that market value CDOs should never be downgraded was about the way those CDOs should be structured, i.e., to immediately go into liquidation and pay off their debt holders when they get into problems. The comment was a criticism of how recent market value CDOs have been structured to dawdle over liquidation and potentially deteriorate further. A better example of optimism in the book is a comment about the benefit of credit default swaps on subprime mortgage bonds which allegedly "allows ABS CDO managers to be more selective about credits and focus more intently on collateral attributes and originator and servicer quality." Ouch. Hopefully the rest of the book is useful to people wanting to understand the structure and attributes of these instruments. Douglas Lucas PS. It seems I couldn't write a comment without awarding the book 1-5 stars. I tried to be objective.