Indeed CDO’s and CLO’s are Back

It seems like 2005 again when investors couldn’t get their hands on enough collateralized debt obligations better known as CDO’s. That single

English: Lehman Brothers headquarters in New Y...

trade took out Bear Sterns, Lehman Brothers, and almost ended AIG.

In case your memory is blurred by everything that transpired with the CDO’s let me refresh it. The CDO was basically a collection of mortgages that were pooled, rated and then sold to investors. For the most part they were rated “AAA” by all of the rating agencies. The problem started when some of them began to have homeowners that could not meet their obligations.

The end result was the bursting of the housing bubble and the subsequent loss of trillions of dollars by the world’s financial institutions and the bankruptcy of many millions of citizens around the world.

But in the investing world things are quickly forgotten. Last week’s enemy is now this week’s friend, and it appears the new friend of many fixed income investors is the CDO. The reason is pretty simple the search for yield. With interest rates still hovering around 150 year lows most fixed income investors are willing to take on more risk than they have in the past and that includes going back to mortgage backed securities.

So far in 2013 more than $38 billion in CDO’s and CLO’S (Collateralized Loan Obligation) have been issued which is more than 110% of the securities issued at this time last year.

There is a reason for this resurgence.

Most banks are not touting the same mortgage backed securities as ten years ago. The new ones have a higher down payment from home owners that give the banks more equity if the owners can’t continue to make payments. Also the housing market has changed. It is not in a bubble now; some of the problem with mortgage backed securities has been solved by the tougher standards, and as usual the market is giving its input too!

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