Credit Crunch Characters (4) - Investment Banks

Securitisation opened up another way to squeeze a bit more out profit out of the 3% to 5% margin. Investment Banks got in on the act and started creating various synthetic securities called Collateralised Debt Obligations (CDOs) that restructured the MBSs by splittin the risk into high and low risk tranches. The low risk tranches came with an AAA credit rating so the cost of funding was further reduced, providing more profits for the bankers.

The problem with these CDOs is that they soon became so complicated that no one, not even their creators, understood the risk. Everyone just assumed that all these instruments were risk free, but no one really knew. Of course we all know now that there much more risk left, than investment banks realised.

The investment banks were either naïve or arrogant.