Banks to sell first post-crisis managed synthetic CDO
This is actually fine. While CDOs were involved in the last financial crisis, they weren&#x27;t the fundamental culprit. That honor would belong to ill-coordinated banking regulations between the US and Europe.<p>In order to provide a public backstop without encouraging moral hazard, banking regulators impose risk-taking limitations on banks. In the US, this took the form of encouraging asset sales into capital markets, under the assumption that this would make any risk the banks take dissipate away harmlessly. In the EU, this took the form of leverage limits based off the credit rating of the asset, with the highest rated asset commanding the largest leverage limits.<p>These regulations combined in a very unfortunate way in the transatlantic CDO trade. The CDO part isn&#x27;t the important innovation, though; as long as the above structure persisted, <i>something</i> would be found to take advantage of it. Anyhow, the short of the crisis is that American banks would sell their risky assets into concentrated positions of systematically important banks, particularly ones outside of the narrow American regulatory purview. On the other side of the Atlantic, they accidentally applied a <i>massive</i> incentive to figure out a way to slap an AAA rating on stuff, and the market delivered that in spades.<p>The cherry on top of this entire system is that when American banks make loans, this cash gets transferred and winds up sitting in some money market fund somewhere. These funds are searching for short-term dollar-denominated yields, and the best way to get that is to lend money to European banks secured by AAA-rated assets. After all, with the generous leverage limits bestowed on them, they can borrow a <i>hell</i> of a lot of money.