What balance sheet benefit resulted when one banks CDO bought another CDOs lower-valued tranches?
A. If one bank bought a piece of another bank’s CDO, then that was truly off the first bank’s books. However, in the late stages of the CDO boom, CDOs were essentially swapping pieces with each other in apparent quid-pro-quos. Here’s a hypothetical: Merrill sponsors “CDO Jesse” and Citigroup sponsors “CDO Jake.” Jesse buys a mezzanine (or middle) slice of Jake and Jake buys a piece of Jesse. Since each CDO owns something that owns itself, it has a less diversified set of assets. Those two CDOs are inherently weaker than they would have been. If Merrill had retained the top portion — or super-senior — of Jesse, and Citi had done the same with Jake, then both banks were more exposed to the risk of losses than they would have been if they had sold the pieces of the CDOs outright to outside investors. Q. The crux of the article is that banks with unsold CDOs on their books put them into pools of bonds to back new CDOs. I just don’t see what is nefarious about that, since the composition
