Collateralized Debt Obligations - A Study on the informal Transaction Transparency

Abstract

Background & Problem discussion: The relative low interest rate in the first part of the new millennium spurred on demand for mortgage financing and by extension also fueled the housing market, primarily in the United States. Subprime loans were incorporated into and repackaged into various ABS. As the house prices declined and the subprime mortgages resetting at increasingly higher rates of interest, borrower defaults. Many equity and mezzanine tranches of MBSs and by extension CDOs were wiped out. The problem of not knowing which securitization investments were good and which were bad led to a halt in investment altogether. Aim and purpose: The main purpose of this study is to qualitatively explore the information exchange between originator and investor of a CDO security. A further purpose of this study is to complement the existing research in the mapping of a CDO transaction. Methodology: This paper examines the human factor in the originator-investor environment of a CDO transaction. Thus, a qualitative approach to the problem is used. Interviews with people at some of the largest financial institutions of the market, actively involved in the investment decision on both originator and investor side has been conducted. Results: The study shows that there exists a mismatch in the information supplied by the participating originators and what is actually demanded by the investors, for purposes of investing in CDOs. The informational demand from the investors reaches beyond the current disclosure requirements enforced by the SEC, and encompasses such intangible aspects that could never be fully conveyed through an investment prospectus such originator brand name. It appears that the perceived success or failure of a CDO relies to a great extent on the individuals involved, and not so much on the structure of the CDO or its underlying assets. In that sense, the human factor, intangible values and the issue of trust surfaces as more incorporated into the decision making processes. In that sense, the term “conveyed information” should encompass a broader definition than the just the investment prospectus. However, if this will be sufficient enough for an investor to make an informed investment decision warrants further studies from the standpoints of the findings of this paper.