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THE CDO MACHINE
lateral, structured the notes into tranches, and were responsible for selling them to
investors. Three firms—Merrill Lynch, Goldman Sachs, and the securities arm of
Citigroup—accounted for more than of CDOs structured from to .
Deutsche Bank and UBS were also major participants. “We had sales representa-
tives in all those [global] locations, and their jobs were to sell structured products,”
Nestor Dominguez, the co-head of Citigroup’s CDO desk, told the FCIC. “We spent a
lot of effort to have people in place to educate, to pitch structured products. So, it was
a lot of effort, about people. And I presume our competitors did the same.”
The underwriters’ focus was on generating fees and structuring deals that they
could sell. Underwriting did entail risks, however. The securities firm had to hold the
assets, such as the BBB-rated tranches of mortgage-backed securities, during the
ramp-up period—six to nine months when the firm was accumulating the mortgage-
backed securities for the CDOs. Typically, during that period, the securities firm took
the risk that the assets might lose value. “Our business was to make new issue fees,
[and to] make sure that if the market did have a downturn, we were somehow
hedged,” Michael Lamont, the former co-head for CDOs at Deutsche Bank, told the
FCIC. Chris Ricciardi, formerly head of the CDO desk at Merrill Lynch, likewise
told the FCIC that he did not track the performance of CDOs after underwriting
them. Moreover, Lamont said it was not his job to decide whether the rating agen-
cies’ models had the correct underlying assumptions. That “was not what we brought
to the table,” he said. In many cases, though, underwriters helped CDO managers
select collateral, leading to potential conflicts (more on that later).
The role of the CDO manager was to select the collateral, such as mortgage-
backed securities, and in some cases manage the portfolio on an ongoing basis. Man-
agers ranged from independent investment firms such as Chau’s to units of large asset
management companies such as PIMCO and Blackrock.
CDO managers received periodic fees based on the dollar amount of assets in the
CDO and in some cases on performance. On a percentage basis, these may have
looked small—sometimes measured in tenths of a percentage point—but the
amounts were far from trivial. For CDOs that focused on the relatively senior
tranches of mortgage-backed securities, annual manager fees tended to be in the
range of , to a million dollars per year for a billion dollar deal. For CDOs
that focused on the more junior tranches, which were often smaller, fees would be
, to . million per year for a million deal. As managers did more
deals, they generated more fees without much additional cost. “You’d hear statements
like, ‘Everybody and his uncle now wants to be a CDO manager,’” Mark Adelson,
then a structured finance analyst at Nomura Securities and currently chief credit offi-
cer at S&P, told the FCIC. “That was an observation voiced repeatedly at several of
the industry conferences around those times—the enormous proliferation of CDO
managers— . . . because it was very lucrative.” CDO managers industry-wide earned
at least . billion in management fees between and .
The role of the rating agencies was to provide basic guidelines on the collateral
and the structure of the CDOs—that is, the sizes and returns of the various
tranches—in close consultation with the underwriters. For many investors, the
