The Role of ABS CDOs in the Financial Crisis

Abstract

We examine the role of asset-backed security collateralized debt obligations (ABS CDOs) as a primary catalyst for the financial crisis. We show how ABS CDOs became the main investment vehicle for the riskiest investment-grade securities in the private-label mortgage market. We estimate a final tally of writedowns on ABS CDOs, $410 billion in total, with $325 billion assumed by AAA and “super-senior” securities, which had minimal capital, margin, or liquidity requirements. Pre-crisis regulations allowed excessive leverage at some firms investing in these securities, imperiling their solvency and placing them at the center of the financial crisis.

TOPICS: Asset-backed securities (ABS), credit risk management, financial crises and financial market history