What's a Securitized Debt Obligation?

In an important way, securitized debt obligations (SDO) is a better term than collateralized debt obligations (CDO), because it mentions the main advantage they claim. Instead of the expensive process of many bank branches painfully assembling a myriad of deposits in order to have enough to lend out as a mortgage, large lumps can be assembled in Wall Street capital markets with little more than a phone call. It is possible to borrow what you need wholesale from Wall Street, avoiding the expensive situation of having more money to lend than requests for loans. Furthermore, the expensive risk of "borrowing short and lending long", that eternal nightmare of the banks, is blunted. And the source of funds available for lending can become national, or international, rather than limited by the savings of local community surrounding the bank. Surpluses can be matched to requirements, another efficiency.

Unfortunately, the creative destruction of bank branches creates one major offsetting disadvantage. The days may be long gone when bank managers would drive around and check whether houses were painted and roofs kept in repair, but still banks had a better idea of the reputation and appearance of their customers than anyone in Wall Street would ever have. Some method of risk assessment would have to be devised to replace the bank's eye on the client. It was devised, it was clever, and it was cheap. Unfortunately, its adequacy for the job is now in question as the CDO market chokes up. If it manages to pass this present test, it will surely replace the expensive old system. If things work out, the present collossal mess will be regarded as a good idea temporarily overwhelmed by its own success.

And if things don't work out, we certainly have a problem.

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