Financial Alphabet Soup

Securitization didn’t stop with plain-vanilla RMBS. Instead, it evolved into a dizzying, mind-numbing alphabet soup of financial products. The most notorious was called a collateralized debt obligation (CDO). This was essentially just a mutual fund for bonds and loans. Like a stock mutual fund, which holds stocks from many different companies, a CDO buys bonds; these can be straight-up corporate bonds, or securitizations backed by mortgage loans, credit cards, auto loans, and so on. One key benefit of stock mutual funds is diversification; they enable investors to avoid the risk of keeping too many eggs in one basket. In theory, the same benefit applies to a CDO. If the CDO invests in a wide enough variety of bonds, it should be less risky.⁷