As we reported last month in our story with NPR’s Planet Money, top investment banks on Wall Street created fake demand for their hottest product – mortgage-backed securities called collateralized debt obligations – in the two years before the financial meltdown. Their activity increased banker bonuses but ultimately made the crisis worse. As real investors fled the market, Wall Street’s CDO machine arranged for CDOs to buy other CDOs.
We have now created an interactive feature that lets you see for yourself one way in which the market became rife with self-dealing. As our story noted, we found 85 instances during 2006 and 2007 where two CDOs bought pieces of each other's unsold inventory. These trades, which involved $107 billion worth of CDOs, approximately a fifth of the market, underscore the extent to which the market lacked real buyers. Often the CDOs that swapped purchases closed within days of each other.
The incestuous trades made the CDOs more intertwined and thus fragile, accelerating their decline in value that began in the fall of 2007 and deepened over the next year.
Using the interactive feature, you see exactly which CDOs owned pieces of each other, which banks underwrote the deals, and which supposedly independent managers were involved in the CDOs. (You can also download our data.) Not surprisingly, the most cross-ownership occurred in the CDOs built by the top CDO banks: Merrill Lynch, Citigroup and UBS. Merrill, the leader in CDO production, had 20 CDOs that exhibited cross-ownership during 2006-2007. Here is a graphic from our interactive feature showing just how often Merrill CDOs owned pieces of each other. (In response to our questions for our story, Bank of America, which now owns Merrill, declined to discuss specific deals, noting that the CDO unit was “discontinued by Merrill before Bank of America acquired the company.")
The CDO with the most cross-ownership during the time was Tabs 2007-7. Created by UBS bank, Tabs owned pieces of four other CDOs that in turn owned pieces of Tabs. UBS declined to comment for our story.
If you look at the data itself, you can see small managers often engaged in cross-ownership. While small, these managers managed a high volume of CDOs in a short period of time. In particular, two CDO managers closely affiliated with Merrill – Harding Advisory and NIR Capital Management – had multiple instances of cross-ownership. Five Harding deals swapped pieces with other CDOs, as did three NIR deals. Both Harding and NIR declined to comment for our story about issues of cross-ownership. Another CDO manager that engaged in cross-ownership was Tricadia, which the New York Times reported bet against the very CDOs it was managing.
