Collateralized debt obligations (CDO’s) have been named once by Warren Buffet as “financial weapons of mass destruction”. Are they?
To say it straight, we at doitinvest.com did a lot of research and the only source of regulations are the indirect ones. The worldwide regulation is Basel II, which requires all the banks to review their assets (including the CDO’s) based on their self-assement of the market values. in other words, I am a bank and i decide how much of a value is this to me. Which is of course a vicious circle and has led to a big splash portion of the recent credit crunch.
Furthermore, the CDO’s have created a new market (as the Economist argues), by transferring the risk of default from on owner to another. But none were regulated in any way – the initial owner because he bought some insurance against it and the new owner because he was reinsuring this. The chain of events led eventually to the mass demise of the CDO’s and to the massive bailout of AIG, which was reinsuring most of the European banks for the risk of default from their CDO’s. And now they (OECD governments) are looking at ways of how to address this.
So another new financial instrument which will take a decade or so to be regulated.