Financial Markets and Institutions (2-downloads)

obligations (CDOs) paid out the cash flows from subprime mortgage-backed secu-

rities into a number of buckets that are referred to as tranches, with the highest-rated

tranche paying out first, while lower ones paid out less if there were losses on the 

mortgage-backed securities. There were even CDO

2

s and CDO

3

s that sliced and diced

risk even further, paying out the cash flows from CDOs and CDO

2

s.

Agency Problems in the Mortgage Markets

The mortgage brokers that origi-

nated the loans often did not make a strong effort to evaluate whether the borrower

could pay off the loan, since they would quickly sell the loans to investors in the form

of security. This originate-to-distribute business model was exposed to