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Collateralized debt obligations: A double edged sword of the U.S. financial system

Author

Listed:
  • Alakh Niranjan Singh

    (Thunderbird School of Global Management)

  • AKM Rezaul Hossain

    (Division of Bussiness, Mount Saint Mary College, Newburgh, New York.)

Abstract

This paper points out a design flaw in Collateralized Debt Obligation or CDO, one of the heavily traded financial instruments by investment banks. The paper suggests that financial design of CDO was not incentive compatible among the players involved in the production, marketing and investing in this instrument. In a CDO, the underlying debt holders (borrowers) have the incentive to default and mortgage service providers (lenders) have the incentive to go for foreclosure because the mortgage insurance providers end up paying for the loss. The biggest losers in this transaction are the mortgage protection sellers like the AIG (American International Group) or the Lehman Brothers and CDO equity holders.

Suggested Citation

  • Alakh Niranjan Singh & AKM Rezaul Hossain, 2009. "Collateralized debt obligations: A double edged sword of the U.S. financial system," Economía, Instituto de Investigaciones Económicas y Sociales (IIES). Facultad de Ciencias Económicas y Sociales. Universidad de Los Andes. Mérida, Venezuela, vol. 34(27), pages 37-56, January-j.
    • Handle: RePEc:ula:econom:v:34:y:2009:i:27:p:37-56
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    More about this item

    Keywords

    Financial crisis; financial instruments; investment banks.;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises

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