Credit Derivatives and Collateralized Debt Obligations
The credit crisis of 2006 to 2011 represented one of the greatest episodes of financial hysteria seen since the Nikkei stock price index (which traded at 8,734.62 on June 25, 2012) reached an intraday peak of 38,957.44 on December 29, 1989. The introduction to this book summarizes much of this mass hysteria, and it is very difficult to resist the temptation to make this a “What were they thinking?” chapter when recounting the tens of billions of dollars lost in the credit markets during this period. As best we can, we will try to reemphasize some common risk management fallacies that we raised in the introduction to this book. We reprise those fallacies in this chapter with specific reference to credit default swaps (CDS) and collateralized debt obligations (CDOs) and how Wall Street responded to market participants who clung to these fallacies as if they were true:
- “If it hasn’t happened to me yet, it won’t happen to me, even if it’s happened to someone else.”
- “Silo risk management allows my firm to choose the ‘best of breed’ risk model for our silo.”
- “I don’t care what’s wrong with the ...