The story of the CDO market meltdown
Collateralized debt obligations (CDOs) have been responsible for $542bn in write-downs at financial institutions since the beginning of the credit crisis. In this paper, [Anna Katherine Barnett-Hart] conducts an empirical investigation into the causes of this adverse performance, looking specifically at asset-backed CDO’s (ABS CDO’s). Using novel, hand-collected data from 735 ABS CDO’s, [she] documents several main findings. First, poor CDO performance was primarily a result of the inclusion of low quality collateral originated in 2006 and 2007 with exposure to the US residential housing market. Second, CDO underwriters played an important role in determining CDO performance. Lastly, the failure of the credit ratings agencies to accurately assess the risk of CDO securities stemmed from an overreliance on computer models with imprecise inputs. Overall, [her] findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.