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CDOs... the real reason for this crash

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posted on Mar, 17 2008 @ 03:53 PM
The real reason behind USA's massive financial slump is what are known as CDOs or Collateralised Debt Obligations and their cousins CMOs, or Collateralised Mortgage Obligations.

Banks are limited by international convention to restrict lending to no more than 14 times their cash holdings, but by getting debts off their books and getting in funds for the sale of those debts (CDO/CMO) banks refinance themselves and expand their cash holdings.

Banks use CDO and CMO products to take debt off their books.

Banks sell these bundles of debt as CDO or CMO in return for the total value of the debt. In reality it is like banks selling their debts to a credit collection agency.

Securities firms who buy these debts return funds to the bank against which the banks can lend again... but hey wait a minute.

The money the banks were paid by securities firms was not money which the securities firms had collected against those debts. It was money for a future unrealised earning.

So now the banks have enlarged their credit worthiness against unrealised debts removed off their books, so that banks can effectively re-lend money they never had.

This way banks in USA have effectively managed to lend up to 200 times their true worth.

What has happened is this created very easy credit and lending agencies fell over themselves to lend money to people whom they knew could not repay.

Those CDOs and CMOs began to fall over in what has become known as the sub prime market collapse.

If America wants to rebuild itself it first has to fix the CDO market and prevent the writing of unbacked credit.

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