Crashed: How a Decade of Financial Crises Changed the World

by Adam Tooze

A surprisingly large share even of nonconforming private label MBS could still attract an AAA rating once combined in structured products. To manage the risks, the production of credit default swaps (CDS), once the preserve of bespoke investment banks, was industrialized. Mainline insurers like AIG offered CDS insurance on exotic securitized products. Given the quality of the underlying mortgages, not all the tranches were good. But that stimulated the investment banks to expand the collateralized debt obligation (CDO) business. CDOs were derivatives based on repackaged middle-ranking “mezzanine” tiers of other securitized mortgage deals. By combining them together and tranching, you could make a large pool of BBB assets yield further tranches of AAA securities. Once you had done that you could then go one step further. You could take the low-rated mezzanine slices of the CDO and pool and tranche them once more to create CDO-squared. And once again by the logic of independent risks and the good graces of the ratings agencies, a portion even of those securities would warrant an AAA rating.