The CDO shuffle

By Felix Salmon
August 27, 2010
cartoon and which includes the phrase "cheerfully feckless". So, go read ProPublica's latest CDO piece right now.

" data-share-img="" data-share="twitter,facebook,linkedin,reddit,google" data-share-count="true">

It’s impossible not to love any story about the insanity of high finance during the bubble years which not only goes into hugely geeky detail but also comes with a cool cartoon and which includes the phrase “cheerfully feckless”. So, go read ProPublica’s latest CDO piece right now.

It’s long, of course — and for good reason: it’s full of juicy details. For instance, did you know that Wing Chau, the CDO manager who was one of the prime villains in The Big Short, ran one CDO called “888 Tactical Fund”?

More substantially:

ProPublica found 85 instances during 2006 and 2007 in which two CDOs bought pieces of each other’s unsold inventory. These trades, which involved $107 billion worth of CDOs, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other, the analysis shows.

That $107 billion — an enormous number — was more than enough, at 20% of the total market, to provide the marginal demand that the market needed to keep prices frothy and bonuses high.

Essentially, the CDO business, in 2006 and 2007, became a con game. Ostensibly, independent managers were picking bonds with the aim of maximizing risk-adjusted returns for their investors. In reality, they existed only to provide a veneer of independence for bankers desperately trying to offload toxic waste that nobody wanted:

“I would go to Merrill and tell them that I wanted to buy, say, a Citi bond,” recalls a CDO manager. “They would say ‘no.’ I would suggest a UBS bond, they would say ‘no.’ Eventually, you got the joke.” Managers could choose assets to put into their CDOs but they had to come from Merrill CDOs. One rival investment banker says Merrill treated CDO managers the way Henry Ford treated his Model T customers: You can have any color you want, as long as it’s black.

It wasn’t just Merrill, either. Goldman was in on the game too:

The firm wrote a November 2006 internal memorandum about a CDO called Timberwolf, managed by Greywolf, a small manager headed by ex-Goldman bankers. In a section headed “Reasons To Pursue,” the authors touted that “Goldman is approving every asset” that will end up in the CDO. What the bank intended to do with that approval power is clear from the memo: “We expect that a significant portion of the portfolio by closing will come from Goldman’s offerings.”

The whole thing is summed up quite elegantly in that cartoon and also in a damning infographic:


ProPublica isn’t the only entity looking closely at all these smelly deals. The SEC is, too:

Asked about its relationship with managers and the cross-ownership among its CDOs, Citibank responded with a one-sentence statement:

“It has been widely reported that there are ongoing industry-wide investigations into CDO-related matters and we do not comment on pending investigations.”

None of ProPublica’s questions had mentioned the SEC or pending investigations.

One can only assume that Citi has received Wells notices about all this — and has decided that they’re not material enough to disclose, even though they’ve clearly had the effect of making Citi go very quiet indeed on the subject.

So go read this story, and all its sidebars: it’s great stuff. If I had to quibble, it would be only over this:

But the strategy of speeding up the assembly line had devastating consequences for homeowners, the banks themselves and, ultimately, the global economy. Because of Wall Street’s machinations, more mortgages had been granted to ever-shakier borrowers. The results can now be seen in foreclosed houses across America.

That is a slightly separate issue from the CDO Shuffle. Insofar as new CDOs were buying tranches of old CDOs, they weren’t buying new mortgages which would ultimately end in foreclosure. But ProPublica gets the big picture spot-on:

Nearly half of the nearly trillion dollars in losses to the global banking system came from CDOs, losses ultimately absorbed by taxpayers and investors around the world. The banks’ troubles sent the world’s economies into a tailspin from which they have yet to recover.

Well done to ProPublica for holding the perpetrators’ feet to the fire.


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Bravo, Sandlers. Bravo Atlantic Misanthropies.

Posted by Uncle_Billy | Report as abusive

We will pay the price ad infinitum and ad nauseum of not temporarily nationalizing most of them.

Posted by Woltmann | Report as abusive

Remarkable details. Even down to the CDO manager working near the Tampa airport..priceless.

I stand by my previous comment made prior, on an unrelated topic:
That is false demand for product, and created a false signal for spreads and structured products.

Posted by McGriffen | Report as abusive

Thank you!

And uncorking CDO’s was entertaining as well as educational.

Posted by hsvkitty | Report as abusive ay/web/2008/10/03/whiteboard_crisis_expl ainer_uncorking_cdos/

Sorry, but instead of pasting the post was entered for some reason.

This info was all much appreciated Felix.

Posted by hsvkitty | Report as abusive

Hot on the heels of an expose of how assuming lognormal returns gives you log normal returns, we have that investments whose mandates include structured financial products invests in structured financial products. Whats next? Maybe we could see parts of Citibank owning shares in BoA and vice versa.

If I wanted to read pathetically weak arguments that don’t even have cursory evidence to back them up combined with wildly misleading conclusions with a faux moral outrage spin, I’d be one of the two people on the planet reading the NYT and Gretchen Morgensen.

Posted by Danny_Black | Report as abusive

danny Black, perhaps you are trying to tell us you think this is all quite alright … rather like doing God’s work or because ‘everyone else was doing it.’ If it is a weak argument, perhaps you would like to tell us why?

What I got from reading is financial institutions were selling watered down wine and calling it champagne and the whole financial industry was in collusion. This is a known fact, so where is the misleading spin?

When they were left with too much water, they coerced banks into buying and threatened to stop giving them business if they didn’t. We can now switch the the hot potato analogy, except the more they traded back and forth the hot potato, the more they got in transaction fees, bonuses and and insurance payouts as they were designed to fail etc.

Are you upset that there are no names behind the those who were willing to speak, albeit anonymously? Tell me which of the bankers, who might take the heat for the whole industry(ala Fabulous fab) if this all comes to a head, did you expect to identify themselves?

Posted by hsvkitty | Report as abusive

hswkitty, except that is simply not the case. There was plenty of demand in 2006 and it only started heading south in 2007 with the collapse in demand only happening around April that year. The whole reason that synthetics existed was because there wasn’t enough supply of underlying bonds and by definition synthetics cannot have caused “more dodgy mortgages” to be issued as they are bets on EXISTING mortgages.

Read the article again and look at the meagre facts they provide – we are talking about investments that came to a grand total of 107billion USD – a quick look at the losses the banks took shows this is a drop in the market. LEH alone was short 150billion when the dust cleared. They took a sample of **structured finance synthetic** CDO – ie CDO whose mandate was to invest in structured finance – and shock horror discovered they invested in CDOs and then shock horror given the small number of eligible CDOs out there discovered some bought slices of each other. You’ll also notice that this is not a case of “banks” doing it rather almost exclusively it was Merrill aka the gimps of the business. Oh and they didn’t coerce banks into doing anything, the people who the article implies were coerced were the CDO managers – who didn’t need much coercing.

It is not a matter of getting quotes, it is a matter of crunching the numbers and showing how this could possibly be significant. They didn’t bother doing this.

I work in this industry, I would LOVE to know how you design a product to fail. Given you seem to think this is easy, I suggest you apply to work for a prop desk at any bank and help them make that risk free money.

Posted by Danny_Black | Report as abusive

Yes Danny Black, there was greed and demand, which is why they were rebundled and why so many mortgages changed hands and are difficult to trace. The high yield/high risk is like crack in the finance world. I don;t deny that.

I see CDOs as a fantasy bet. One which was continued to be kept afloat by fluffing it up with fake ratings. It wasn’t just existing mortgages, it was subprime… and when they dried up the brokers went out to coerce anyone who could be duped into buying one.

I would think that being 25% of US mortgages were ‘unconventional’ that the subprime mill was a great place to play such high finace lottery. Being mortgage brokers were selling mortgages to people with no little or no credit and the banks were quite aware AND those who were shorting were quite aware which banks and lenders were allowing such mortgages to go through … and those mortgages ended up in an AAA rated CDO packages … and people like Paulson were allowed to pad the CDO package he was about to short himself… etc… i would say there were lots of instances where insider trades and shorts with insider knowledge were more then a possibility. The kind of money made from other people’s money is just too good to pass up.

Make a product so complex and backed by third party independents like Paulson, who isn’t independent at all as he helped package the CDO and is going short and that’s how you can design a product to fail. Should I have said fall short of implied expectations? It gives a whole new meaning to calculated risk. Pass the bonuses please.

That the further watered down CDOs which were still left in someone’s hands were now a hot potato didn’t stop the mill after they were found to be as worthless as those who had faked their value KNEW them to be… it just became the hot potato with bonuses given to those who were able to rid of them, kept the demand high as well as the ratings.

The hot potato time bomb..CDO shuffle… watered wine …call it what you will, but it was still repackaged junk, no matter the ratings. 2/wsj-mortgage-hot-potatoes.html

Posted by hsvkitty | Report as abusive