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CDO Collateralised Debt Obligation

This is an asset-backed security that we were never meant to hear about until the Summer of 2007 when previously rich traders couldn't sell them to each other for love nor money.

Essentially, with a CDO a debt is broken down into little pieces and repackaged and sold on in senior and junior debt tranches, rated AAA though BB to unrated equity (that is, high risk).

If anything goes wrong senior debt gets repaid before junior debt. Typically, senior debt, being less risky, has a lower yield and is considered a safer bet. (Remember, it's all a bet, however good their suit and however white their smile.)

More interestingly - or panic-inducing if you are exposed to these leveraged instruments - is that the value of many CDO's are unknown to both the holder and the seller because of their intricate constituent parts. They are, afterall, comprised of bits of loans from all over the markets. Obviously, because people are lazy and loathe to expose their own ignorance, this all goes unquestioned for the most part. For which read "whilst everybody is making money". Except that at some stage the markets head South. And then the finger pointing begins.

When markets become shaky - as they were in the Summer of 2007 - everybody tries to offload the undesirable CDO's except nobody wants to buy them. So they are instead forced to sell their higher quality holdings, blue chip shares and the such. As a consequence other markets begin to fall and the cause of the fuss - CDO's - are downgraded yet again and even more holdings need to be sold. And thus the vicious spiral continues until everybody wakes up to the fact that the markets are just one big casino and the loss of one spin of the wheel shouldn't be a cause for mass hysteria.

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