Collateralized Debt Obligation Problems

The year 2007 may become known as the Summer of the Sub-Prime Mortgage Meltdown. You can not read the financial or business news without being aware of the growing concern over the issues related to sub-prime mortgages.

Sub-prime mortgages are offered to individuals with modest income and poor credit so that they can become homebuyers. Such mortgage loans often have below market teaser rates that will rise to above market level after the introductory period. Such mortgages are usually extremely difficult to refinance. Often the homeowners can no longer afford the mortgage payment once the interest rate increases to market rate or if the homeowner loses his job. Consequently, such mortgages have a relatively high rate of default and that rate is increasing.

But the homebuyers are not the only ones to suffer from the collapse of the sub-prime mortgage market. These mortgages are sold to Wall Street investment banks that then “securitize” the mortgage by pooling the income stream from many such mortgages into bonds known as collateralized mortgage obligations (“CMOs”), mortgage-backed securities (“MBS”) or asset backed securities (“ABS”).

Starting in the late 1990s, investment banks began creating mortgage-backed securities out of sub-prime mortgage loans by pooling loans and slicing them into various classes having different benefits and risks. Pooling the loans purportedly created a cushion against default by diversifying risk, and the higher interest rates gave such bonds the high yield that investors favored. Many of these classes or tranches were sold as “AAA” or “AA” rated.

The investment banks then created what are known as Collateralized Debt Obligations or “CDOs.” The CDO entity buys and bundles different kinds of debt – often ranging from these mortgage-backed securities to corporate bonds to debt backed by credit card payments. The CDOs are then cut into different slices (also called tranches) and sold to investors in the form of bonds. While these slices contain the same debt, they differ in terms of preference, interest payments, and risk. Slices that pay the least interest are the safest if there are defaults in the debt pooled in the CDO. Slices that pay the most interest are generally the first to go bust in the event of defaults. Many of these tranches are also rated “AAA” or “AA.”

Because of the CDO structure and the diversification gained by bundling different debts, underwriters have tried to package these high-risk debt instruments in a manner to receive investment grade ratings. The CDOs often use borrowed money or leverage to increase returns.

The CDOs are sold to investors, including hedge funds, pension plans, and mutual funds. Because they are illiquid and do not trade regularly, it is difficult to value the CDOs accurately. As the sub-prime defaults have increased, there is concern that these instruments have not been properly valued. Bear Stearns has been in the news because two hedge funds it manages have been wiped out by sub-prime mortgage losses.

Attorneys at Page Perry are actively involved in this situation and are assisting investors who have losses because of these complex sub-prime mortgage investments. Page Perry attorneys have successfully handled cases involving complex CMOs and mortgage backed securities for the past 20 years.

If you have investment losses or problems involving CDOs, call the lawyers at Page Perry for experienced representation at (770) 673-0047 or (877) 673-0047 (toll free).