Read it here first: The CDO-Enron Connection

In Paul Krugman’s NYT’s OpEd column this morning, he compares the CDOs with Enron  and wonder’s where the ratings agencies were during the subprime expansion:

"Seriously, it’s starting to look as if C.D.O.’s were to this decade’s housing bubble what Enron-style accounting was to the stock bubble of the 1990s. Both made investors think they were getting a much better deal than they really were. And the new scandal raises two obvious questions: Why were the bond-rating agencies taken in (again), and where were the regulators?"

Regular Big Picture Readers will recall last week’s posts on each of these subjects:

CDO Hedge Funds = Enron ?
10 Questions About CDOs

I’m just sayin’ . . . 

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Discussions found on the web:
  1. semper fubar commented on Jul 2

    Well, he has to get his information from somewhere, doesn’t he?

    Guess he’s a fan too, Barry. :-)

  2. Ross commented on Jul 2

    where were the rating agencies? Same place as last time. In the pockets of them what pays em.

  3. peter from oz commented on Jul 2

    semper fubar
    you got in first with that comment
    on to the next ripple leading to the tsunami
    rgds pcm

  4. Idaho_Spud commented on Jul 2

    A hat tip would have been nice!

  5. REW commented on Jul 2

    Yeah but BR can’t claim to be a former Enron advisor like Krugman!

    Bear Stearns made a huge mistake bailing out their funds. They take something that was legitimately off their books and put it on page one. Regulators and trial lawyers will now expect all the off the books funds to be considered part of Bear.

  6. Kp commented on Jul 2

    There will always be opportunists who will try to create spread where none previously existed(CDOs, CMOs,etc) and plenty of people will to buy their creations in the interest of satisfying their own greed. The stink doesn’t ever get raised until someone losses money….then suddenly it’s all wrong and every one wants their money back. Talk about missing the point.

  7. John F. commented on Jul 2

    There seem to be some fixed-income super experts among your readers; perhaps they can tell me if this is all wrong. It seems Enron provides a weak analogy. Enron’s derivatives were wildly complex and designed to cover up illegal behavior. CDOs by themselves are not rocket science and at worst provide a way to offer sucker bets to investors reaching for yield. The complexity arises from the difficulty of estimating default rates, conflicting interests dealing with non-performing loans, and of course downstream issues like leverage. But Krugman is to weak analogies as a fish is to….oh, never mind.

  8. Perplexed commented on Jul 2

    Why does the IVV differ from the SPX? For example as I write this, the real-time feed shows the SPX at +0.74% for the day, while the IVV indicates +0.65% for the day. What gives?

  9. Philippe commented on Jul 2

    When trying to assess the reliability over the time of rating agencies I found the website of the federal reserve of Boston the most appropriate and the most informative for this purpose(please see stock markets Federal reserve bank of Boston)
    In a nutshell rating agencies are not worried they have more upgrades than downgrades since 2001 and do not count on them to see the risk inflection point they only started to downgrade issuers in 2002 and it took them two other years to reach the median of their average assessment.
    No surprise !

  10. anon commented on Jul 2

    Bush Administration and regulatory oversight in the same sentence?

    You’re kidding, right?

  11. adam commented on Jul 2

    i think there’s a big difference.

    enron was fraud. CDOs were packaged and rated with leeway given for historical levels of defaults (that still haven’t been reached). if the highly rated CDOs default, people have a reason to gripe. until then…

  12. D. commented on Jul 2

    If CDOs did not sell, chances are the whole real estate bubble would not have occured. Someone along the line knew millions of mortgages were being mispriced. They did not care because they could offload the risk to investors. That is fraud.

  13. adam commented on Jul 2

    how is that the rating agency’s fault? they don’t package the CDOs, they just rate what is given to them. these mortgages were being created because people were buying the CDOs, not the other way around

  14. Stuart commented on Jul 2

    Adam, you’ve got to be absolutely over the top to for one second assert these CDOs weren’t deliberate mis-represented in terms of risk and quality to the investors who bought them. Lets get real here now that so much has been revealed so through many written pieces on the matter. The whole bloody thing is a ponzi scheme built on deception enticing investors to buy products supported by a financial infrastructure that wants to keep its dirty little secrets in the closet. Deliberate misrepresentation of financial products is fraud and ratings agencies were part of it, just like the accounting firms were complicit in Enron. Hmmm… how can we get all these ford pintos described and quality rated as toyota camries. Lets ask the automotive rating agencies. Throw in 15 Pintos with every 85 camries that way you can say per 100 cars, they receive the top quality rating. Great idea toyota camries. We’ll bury them in and hide them so we can get enough BBB- crap blended in with real AAA+ camries, just enough so we can still claim the whole batch is AAA+ rated. SShh, now don’t tell anyone, we’ll just sell the whole lot of cars as AAA+ and not tell anyone about those pintos. No, no deception there. And the toothfairy is going to save us all.

  15. Eclectic commented on Jul 3

    Mr. Krugman,

    I’m going to answer your question with this parable, but you’ll first have to absorb yourself in the emotions of human psychological momentum in order to understand it. The answer is in the parable:

    I’ve used this before, but it works here very nicely as well. Part I is about the emotion and momentum that gets people into trouble and Part II is about the emotion and momentum that keeps them in that trouble and possibly destined to suffer from it.

    Imagine the following:

    Part I

    You’re an experienced jumbo jet captain with 25 years of experience. You’ve never had an accident of any sort although there have been a few tight spots.

    This afternoon your plane is loaded with 306 passengers and crew, including yourself, and you’re sitting at the gate a few minutes behind schedule; should have been pushed back 10 minutes ago. Your flight is supposed to connect to Atlanta in about 4 hours.

    There are still some unavoidable delays and 10 minutes later you finally get pushed back and taxi out into a very long line of other aircraft waiting to take off. If you’d not been delayed, it would’ve been 3 or 4 ahead at most and by now you’d be near cruising altitude. If you miss your gate time by too much in Atlanta, the company will be hosting a very expensive list of hotel guests tonight, and things are beginning to look like you might miss it.

    As it is, you’re basically in a linear parking lot of heavy iron, and as you taxi at wheelchair speed you notice a large thunderstorm darkening the sky in the distance, even as there’s only sun and cloudless blue sky above you now. Boy, you wish you were getting the okay for takeoff now, but what will it be like in another 20 or 30 minutes?

    There are still 10 ahead but you’re down near the end of the taxiway now, and you can see cleared flights ahead of you take the 180 degree turn, sit a moment, and thunder by you in the opposite direction. But now incoming flights are reporting wind shear on their approach legs to landing, and part of the thunderstorm is wrapping around and beginning to threaten the departure space. Each time a flight turns and departs you get closer to takeoff, but the thunderstorm gets closer as well.

    Now, finally, you’re up next and you are cleared to turn and hold the runway for takeoff clearance. As you turn, you get a really good look at that thunderstorm. Damn!… that’s close, far closer than you’d hoped. You call the tower and ask about windshear at the airport. “None reported,” the controller says, but incoming flights are beginning to get put into holding patterns now because of pilot reports of severe turbulence on approach.

    From your perspective now, sitting on the end of the runway, it can’t help but be worsening at least a little in the departure zone, but the flight ahead of you was cleared just a minute ago and he’s airborne. You’re next. While you wait, you look back down the line of aircraft now facing you and you can taste the tension they have as they wait for your wheels to roll them closer to a takeoff for themselves.

    Another look at that thunderstorm… it’s still closer it seems… don’t know if this is a good idea. There are winds in that thunderstorm that will steal the lift from over your wings and put you and your fellow 305 souls in a big pile of fire, smoke and twisted metal just off the airport grounds. But the tower still reports no windshear from electronic detectors near the runway. The next turning flight behind you for takeoff is so close you can see the eyes of the captain and copilot watching you.

    At that instant, the tower says your flight is ‘cleared for takeoff.’ Now the moment is all yours.

    What are you going to do?

    After waiting in that line so long… and while watching flight after flight take off… and after being told 2 or 3 times that there’s no windshear, there you sit with your hand on the 2 throttle controls connected to giant air-sucking monsters that will give you what you’ve been waiting for.

    Your copilot is watching you and waiting for your instructions like your pet dog waits for table scraps.

    The thunderstorm is even closer now, and you’d pray for the relief that would come if the tower canceled your clearance. But, no… all you hear is the tower repeat your clearance for takeoff. You’re sitting there like a dummy, cleared for takeoff but the sweat is beading on your forehead.

    All the captains in all the flights behind you also heard the first and repeat clearances for takeoff… so “why are you still sitting there, fool?” All this is flooding your brain in just seconds or fractions of seconds, and you now only have one last tiny fraction left to make up your mind.

    What’s it going to be?

    You can refuse the clearance if you want to, but then you’ll have to taxi at wheelchair speed again down the active runway to the nearest turnoff, and there you‘ll have to wait until ground control moves some of the departing aircraft behind you out of the way just so you can go lamely back to the gate. And when you’d turn off the active runway, you’ll have to hear the flight that was behind you thunder into the air… and know that its captain and copilot are whispering about you to themselves, “fools.”

    If you refuse the takeoff clearance, you won’t be able to get back in line again even if you wanted to, because your copilot worked an extra flight this morning and he’s due to be off the clock before you could get to the arrival gate in Atlanta with another huge delay. Not only would a number of connecting flights at Atlanta now be without their passengers who are on your flight, but you’ll have to put them in hotels tonight in the big city where you are, and it’s possible they might miss connections again tomorrow and stay another night in Atlanta.

    What are you going to do?

    You’ve been flying most of your adult life and every instinct inside your body and soul says, “Don’t go!” But everything in your chain of momentum; your company, the passengers, your copilot’s eyes, the flights behind you and the controllers are all telling you, “Go… go… go now, fool, what are you waiting for?”

    So, what are you going to do?… You’ve now had an extra thin second to think, but you’ve got to do something and do it now. What’s the decision? We don’t have all day.

    Pause a moment and think of what you’d do, and then read:

    Part II

    Okay, so you’re the captain of this jumbo and you’ve made the decision. It’s a go.

    You and the copilot join your hands on the throttles and push them firmly over to maximum power. The engines whine up and that massive sense of thrust begins to press you back into the seat. We’re on our way!… You’ve finally done this and it’s a “Go!”

    The tension immediately passes from your body and soul and routine takes over.

    One fraction of a second after the throttles are pushed, your copilot hears a garbled sound, a tiny clicking sound, over his headset. He knows from experience someone may be having their microphone transmissions “stepped on” (when two simultaneous communications can’t both be received), and if it’s the tower’s mike getting stepped on by another aircraft’s transmission to the tower at that exact same instant, then “What might the tower have been trying to tell us?” he thinks.

    Another fraction of a second later, your copilot tells you, softly at first, “We’re not… I don’t think, uh.. I don’t think we’re cleared,” but he begins to say it much louder as you continue down the runway, gaining more and more speed.

    You’d not heard the tiny clicked hint of a stepped mike and tell him “We’re cleared for takeoff! They cleared us!”

    Finally, the copilot almost yells the warning that he thinks the clearance has been “deleted,” and that you should “abort!”

    Now you’re almost moving too fast to abort, but in 1 or at most 2 more seconds you will be beyond aborting.

    The thunderstorm has now actually entered the immediate area at the other end of your runway, and it’s raining now so hard there that you can’t even see the end, and you couldn’t see another aircraft either if it were waiting there for you to slam into it as it crossed the runway with the clearance you thought you still had.

    Even yet the powerful urge you’d just had to refuse the takeoff clearance in the face of this dangerous thunderstorm is weighing heavily inside your head.

    What are you going to do now?…

    You wanna be twice the fool?… once for sitting like a chicken on the end of the runway with half the flying public lined up behind you?… and now again as you abort and possibly end up, brakes locked, tires screaming and smoking, sliding to a disturbing grinding halt beyond the runway’s end marker?

    That’ll get the blow-out emergency escapes inflated and you’ll see broken hips of old ladies when you finally get to the bottom with them. It’ll close the airport for hours. They’ll investigate what happened.

    You’ll get to tell ’em your dumbass copilot talked you out of an unambiguous takeoff clearance. Of course the tower will agree with that, so you’ll be the bigger fool still.

    What are you going to do now?… Think about it hard and fast… you’ve got another 1/2 second… that should be enough for a professional with your training, background and expertise.

    So, what’s the word, J-Bird?… What are we going to see happen now?

  16. adam commented on Jul 3

    packaging lots of BBB paper and pricing in defaults to create a higher rated piece of paper is what CDOs are supposed to do and what allowed people to buy homes who might not have otherwise been served (a good thing for those responsible people who can afford a home but have bad credit). obviously loans were given (and in many cases pushed) on people who could not afford them. however, my only point was that ratings agencies are not investigators, nor are they regulators. if properly documented mortgages are being brought to them by financial institutions, they rate what they get (just as they rate a company’s audited financials that may be BS).

  17. Stuart commented on Jul 3

    I don’t question the purpose of packaging up BBB paper as long as people know they are buying BBB paper. In short, they were deliberately repesented as higher quality than they were in actuality and rating agencies played a willing role in this fraudulent disclosure. So the sellers were fraudulent in the misrepresentation of risk and quality. In many cases this would’ve been suspected or perhaps known by the investors, in many cases not. Either way it still does negate willingness to take active steps to overrepresent the quality. Now that the whole planet knows there is no liquid market for them and the underlying assets and the conflict of interest in marking to model, their value must be written down since they continue to carry these assets on their books at values far exceeding their true worth. Except for a handful of publicized cases, the agencies are not, at least not without a whole lot of pressure updating their ratings to reflect assets, bonds at true value, not par value which can no longer be attained upon sale. The entire industry wants to avoid write downs and the ensuing losses. One can understand that, but that is part of the system- risking capital to earn gains. Now that it swings back against them, cover up potntial losses, fraudulent disclosure of risk is the new name of the game.

  18. Eclectic commented on Jul 4


    Excellent piece you linked. It’s the best description I’ve seen in any media.

    You can fit it to my parable like a hand fits in a glove.

  19. Eclectic commented on Jul 4


    I read your link again today, slowly… and when I got finished I had a better understanding than when I’d only read it twice to begin with.

    This is the kind of material that the average person would need to read multiple times just to get a grasp of the boldness and recklessness employed in putting these obscure financial vehicles together.

  20. Stuart commented on Jul 5

    glad it helped. It was very well written I thought and certainly helped my understanding, particularly with respect to those synthetic CDS’s. Crazy. Spread the link around as I’m sure it will help consolidate a firmer understanding for many others as well.


  21. Winston Munn commented on Jul 5

    Stuart and Eclectic:

    My understanding of the CDO/subprime connection is that the equity tranch is such a minority part of the entire CDO that it allows the entire CDO to be rated as investment grade, which means, because it is part of the CDO, the equity and mezzaine tranches also carry investment grade ratings.

    Why would this be important? Law forbids pension funds, retirement accounts, and the like from investing in anything other than investment grade bonds; however, as all parts of the CDO are rated investment grade, pension funds, etc. can legally stretch for yield by investing in the lower end tranches.

    Basically, to me, the inclusion of subprime MSBs into the CDOs looks like an end run around the law.

    When the losses start piling up in state retirement accounts and pension funds, it should prompt a litigation nightmare of pin-the-blame-on-the-jackass-who-sold-me-this-it-wasn’t-us-it-was-the-rating-agency-who-lied-not-us-the-mortgage-comapany-lied-first-don’t-blame-us-we’re-innocent-the-damned-customer-lied-about-his-income sort of legal holocaust.

    If nothing else, it should be entertaining to watch.

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