Collateralised Debt Obligations and the Financial Crisis

Abstract

The object of this paper is to give an overview of the collateralised debt obligation (CDO) market and the role CDOs played in the financial crisis. As most of the specific features and risks of the CDO market are due to its regulatory treatment, the paper focuses mainly on the pre-crisis regulation of CDOs in the United States. Section II and III describe the functionality of a CDO and illustrate its main application purposes. Section IV highlights some of the shortcomings in the CDO market and explains how they contributed to its failure. Section V displays the main features of CDS regulation in the United States. Section VI outlines the connection between the subprime crisis and the failure of the CDO market. Finally, section VII overviews a number of regulatory proposals which could mitigate some of the perils of the CDO market.