Subprime and Synthetic CDOs: Structure, Risk, and Valuation*

Article by Dr. Elaine Buckberg, Dr. Frederick C. Dunbar,¹ Max Egan, Dr. Thomas Schopflocher, Dr. Arun Sen, and Carl Vogel

INTRODUCTION

Collateralized debt obligations (CDOs) and other structured financial products containing subprime mortgages have been a focal point of the credit crisis, giving rise to a growing amount of investigative journalism as well as credit crisis litigation. It is widely agreed that the leading edge of the credit crisis was the meltdown of the US subprime mortgage market that began in early 2007. Many of these mortgages were structured into asset-backed securities (ABS) that were then further structured into CDOs. Through these processes, exposures were propagated throughout the financial system, ultimately resulting in widespread losses. Concerns about the depth of these losses led to uncertainty about counterparty risk, causing the credit markets to freeze in August 2007. These fears were magnified in the financial market panic