Chicken Breasts and Collateralized Debt Obligations

I’m really trying to understand what caused this economic meltdown. I’ve been reading a slew of articles in the New Yorker and Columbia Journalism Review. I think I may have finally cracked the code on CDOs and credit derivatives and securitization. Here are some tidbits that helped clear the fog:

Sensible bites

Debt – there is too much debt, which is causing banks to go under, the credit freeze, people to go bankrupt and their assets to fall…Ok, duh..

It’s like poultry – “You can turn a bunch of whole chickens into packages of chicken parts, of ascending quality, from gizzards to breasts, and chargea premium for the best cuts…(New Yorker, 5/18/09, Nick Paumgarten)

• CDOs – collateralized debt obligations – are packaged chicken parts, which have different ratings…
• chicken breasts were the AAA-rated credit risk – banks were hungry for them, but not that many companies qualified for AAA rating
• So traders created synthetic debt – credit-default swaps, which weren’t so much debt but bets on debt
• These were pooled and sliced like gizzards and legs and wings and packaged as valuable
• the problem was, eventually, that gizzards were packaged as breasts. And then there was the salmonella.”
• “the peddlers of the chicken shit paid to have it magically pronounced chicke nsalad, a conflict of interest that most investors ignored.”
• In the end, “you can’t make chicken salad out of chicken shit”

Banks become glorified hedge funds instead of doing their normal jobs – taking deposits and making loans

Government bonds delivered an 80 percent return in the last decade. “The real action over those ten years, however, took place in riskier bonds and the complicated “swaps” that gained and lost value in tune with the market’s perception of their creditworthiness and the direction of interest rates.” – per Columbia Journalism Review

Swift technology – if the numbers didn’t work in your data models, you made them work

Also, here’s a brief dictionary of terms I can turn to when I get turned around…

Personal Glossary

• boiler room – a fraudulent, corrupt brokerage firm, refers to the bad mortgage underwriting of borrowers with bad credit that led to subprime loans
• derivatives – unregulated securities that are difficult to invest in and get pricing data for
• CDOs – collateralized debt obligations, bets on credit, or as NYer calls then “formerly high-flying and now leaden assemblages of securitzed debt.”
• credit default swaps – a form of deritivate that rises and falls according to underlying bonds; there’s no exchange or clearinghouse for them, yet 100s of trillions of dollars in “notional” value were tied to tehm
• credit “swaps” – bets on the market’s perception of their creditworthiness and the direction of interest rates
• mortgage-backed securities – mortgage are sliced up and packaged and sold in securities
• Wall Street connection – all major investment banks bought a retail subprime operations and had in-house lending operations