There’s a lot of funky financial terms getting thrown as we try to explain how the money meltdown started in the first place, and one of the funkiest is a CDO or “collateralized debt obligation.” Luckily, Paddy Hirsch from Marketplace is here to explain it using just champagne glasses, a whiteboard, and a sexy British accent..
Crisis explainer: Uncorking CDOs from Marketplace on Vimeo.Basically, the CDO manager has a champagne bottle filled with mortgages. Every month when the debtors pay their mortgages, it fills the bottle with payments. The cork pops off and he pours the bubbly over a tray of glasses, each one representing a tranche of increasing risk.
The glasses at the top, rated AAA, get paid first and the least amount, and the bubbly flows down to AA, BBB, BB and equity, the tray at the bottom.
The party gets bad when people stop paying their mortgages. Now the bubbly only reaches the first levels, and the BB and the equity don’t get paid at all. To make it worse, we have a SECOND CDO manager.
His bottle, instead of being filled with the mortgages, is filled with the BB-rated securities. When a few people stop paying on the first bottle, that means his bottle has no juice at all. He has a whole champagne glass tower with glasses rated AAA through BB like the first one, but it’s not getting filled up at all. Then the champagne towers fall over and crash and Wall Street evaporates and there’s runs on the bank some wisenheimer paints the Wall Street bull’s balls blue. That’s CDOs for you.
If you enjoyed that one, he also made another video explaining Credit Default Swaps, which are what brought AIG down.
Crisis explainer: Uncorking CDOs [Marketplace]