Essay: Collateralized Debt Obligations
Since Hedge funds are unregulated, in their quest to surpass the stock market it became clear that they had been used to buy many subprime mortgages, which were not performing at that time. All kinds of debts were being repackaged and sold as Collateralized Debt Obligations (CDO’s) which were difficult to price since they were new in the market. As the prices of homes continued to decline those homeowners who depended on their homes as sources of income were affected. It became difficult for many people to service their debts.
The CDO’s were held by Hedge Funds, corporate, lenders as well as pension and mutual funds and individuals. Since many banks were holders of these CDO’s. As the debt default increased, it meant the lenders could not sell their holdings, which meant less money to lend. Those who had money could not accept to lend to the banks that could default. Towards the end of the year 2007, the Federal Reserve had to come in and save the situation as banks were lending too little which meant further decline of the real estate. Very many financial institutions went bankrupt and had to be bailed out by the government. The Lehman brothers was taken over by other banks.