Ya'll know by now what a CDO is, but if you don't...CDOs are collateralized debt obligations that are financial instruments (think of them as bonds) that are packages of many thousands of individual mortgages. The person holding the CDO is collecting (or not collecting) all of the monthly payments of all the mortage holders in his CDO. For more detail, check out the famous stick-figure primer. (Click on the arrows on the bottom left of the page.)Anyhow, in last week's Observer, Wolfe makes a great point. Back in the 80's (think Liar's Poker), banks used to review every single mortgage, on paper, by hand, before purchasing a CDO. What's more, they even rejected indivudal mortgages from a proposed CDO and threw them out before buying the CDO. This prevented any of the subprime crap from sneaking in.
Wolfe notes that computers sped this process up, and made it inconvnient and seemingly unnecessary. He's right. But further, the dynamism of the market, the ability to move quickly in and out of positions, knowing that you could easily sell your CDO next week, lowered the standard of scrutiny and led the the mess that we have now.
Wolfe writes...
"The whole thing, starting with the subprime, is the fault of the computer. I was just talking to a banker the other day, and not that long ago, 20 years ago, an investment banking house, let’s say, Lehman Brothers, when it got a package of mortgages, they would go through every mortgage, every single one, and they’d throw out the ones that just seemed absurd, they just wouldn’t accept them. Things used to arrive on paper. Today things arrive on a screen, and a screen is back lit, and one of the biggest pains in the neck is trying to read something dully written and complicated on a computer screen. It will drive you nuts—I mean, try it sometime. Now they say, ‘Oh, to hell with it,’ and they just accept the whole package. And if it hadn’t been for that, they’d be going over each loan. What’s happened is the backward march of technology"The next question is, Where was Moody's and Standard & Poor's in all this? And when do they become accountable?
