Welcome to European Tribune. It's gone a bit quiet around here these days, but it's still going.
CDOs don't transfer ownership of house : they are insurance contracts. The owner of the equity tranche pays a pre-decided amount of money while the first n% of the basket of loan takers default ; and indeed the tranches aren't pre-sorted, which is the whole point of CDOs : it was supposed that if you took a bunch of loans, even though they were bad, it was unlikely that more than 50% of them would default, thus AAA rating for the senior tranches.

The problem in valuing such CDOs being that in a crisis, like a bursting of the housing bubble, the probabilities of individual subprimes loan takers to default become highly correlated rather than independent events ; if one underestimated that correlation, one overvalued the senior tranche of the CDO, which is why some end up being hit unexpectedly, having to pay premiums they didn't think they'd have to.

Un roi sans divertissement est un homme plein de misères

by linca (antonin POINT lucas AROBASE gmail.com) on Mon Aug 20th, 2007 at 03:02:30 AM EST
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