CDOs and CMOs by Malcolm Berko on Creators.com

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CDOs and CMOs

Dear Mr. Berko: Two years ago, I bought $150,000 in Collateralized Debt Obligations and $46,000 in Freddie Mac and Fannie Mae preferred stock. My broker told me they were AAA rated and you know the rest; everything went down the tubes. I'm going to sue my broker. Can I do it without a lawyer to whom I'd have to pay 40 percent of what I get? Please answer ASAP. Can you tell me why this CMO/CDO thing is so complicated and explain it without using complicated terminology? I need to understand this better if I sue by myself. — S.N., Walton Beach, Fla.

Dear S.N.: Ouch! Holy cow, great Caesar and jumpin' Jehosephats! It's a small wonder that the king's men couldn't put Humpty Dumpty back together, that Miss Bo Peep lost her sheep and Brer Fox wanted to eliminate Brer Rabbit. No one seems to know who or what's going on in this financial tumult. Please do not blame that broker for your $150,000 loss in Collateralized Debt and the $46,000 loss in Fannie Mae and Freddy Mac preferred shares. Those CDOs were AAA rated by Moody's and Standard & Poor's even as they were sinking so deeply into financial quick sand that neither Superman nor Popeye could pull them out. Your broker trusted the Triple A ratings from Moody's, Standard & Poor's and Fitch, who competed against one another for the lucrative business of rating securities. These agencies bribed their customers, promising AAA ratings to secure their business. In other words, S&P, Moody's and Fitch cavalierly promised the issuer of those CDOs (Merrill, Lehman, Goldman, UBS, Credit Suisse) the highest rating levels and in return, those issuers offered to pay the rating agencies hugely handsome fees.

I also place the blame for your Freddie Mac and Fannie Mae losses on Rep. Barney "The Baloney Man" Frank, who, a week prior to their bankruptcy filing, announced on national TV that both agencies were solid gold. I believe Moody's, S&P and Fitch should be sued for misfeasance, malfeasance and their reigning executives be placed in chains to rot in a Turkish prison and their families forced into penury. The money lost by the infamous Bernard Madoff pales in size to the losses in the bond market and financial pain suffered by millions of individual investors and their retirement plans due to the infamy of Moody's, S&P and Fitch.

If we can't trust Wall Street, if we can't trust the banks, the insurance industry, the Securities and Exchange Commission, Congress, lawyers, the brokerage industry, mortgage brokers, real estate agents and credit card companies, who the heck can Americans trust? Darned scary, isn't it? But don't sue that broker because there is no way in paradise or perdition that he could have known those CDOs or Fannie and Freddy were short-fused, waiting to explode. You might consider contacting a tort lawyer and initiate a class-action suit against those agencies. And millions of investors who also got snookered might join you with alacrity.

Here's an example why these things are so hard to understand. CDO securities are comprised of thousands of Residential Mortgages Backed Securities forming a mortgage pool. The pools are sliced into "tranches" and sold to investors. The tranches on the top rung of the ladder are rated AAA and have the lowest returns because they had almost no risk. The tranches at the bottom are unrated and have the highest yields. Here's how it gets mucked up: In many cases, tranches from one mortgage pool are combined with tranches from another pool that result in Collateralized Mortgage Obligations. The other tranches were mixed with tranches from completely different pools containing auto loans, credit card receivables, small business loans, etc. is called Collateralized Loan Obligations (CLOs). And when CMOs are mixed with CLOs (kind of like hobo stew), the new brew is called a Collateralized Debt Obligation. And when the tranches of CDOs combine with other CDO tranches, the resulting mix called CDOz becomes complicated by orders of magnitude.

Assume a CDO was blended with another CDO and together they own 100 CLOs with each CLO holding 300 small-business loans. To determine the value of this security, you would need information on (100 times 300) 30,000 small businesses. But if your CDOz was blended with 50 CDOs each owning 50 RMBS comprising 1,000 mortgages, you must have up-to-date loan data on 2.5 million loans. And the blithering idiots responsible for this toxic stew should be posted to a penal colony in Siberia.

Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com. To find out more about Malcolm Berko and read features by other Creators Syndicate writers and cartoonists, visit the Creators Syndicate website at www.creators.com.