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10

THE MADNESS

CONTENTS
CDO managers: “We are not a rent-a-manager”..............................................
Credit default swaps: “Dumb question”..............................................................
Citigroup: “I do not believe we were powerless”..................................................
AIG: “I’m not getting paid enough to stand on these tracks” ..............................
Merrill: “Whatever it takes”...............................................................................
Regulators: “Are undue concentrations of risk developing?”...............................
Moody’s: “It was all about revenue”....................................................................

The collateralized debt obligation machine could have sputtered to a natural end by
the spring of . Housing prices peaked, and AIG started to slow down its business
of insuring subprime-mortgage CDOs. But it turned out that Wall Street didn’t need
its golden goose any more. Securities firms were starting to take on a significant share
of the risks from their own deals, without AIG as the ultimate bearer of the risk of
losses on super-senior CDO tranches. The machine kept humming throughout 
and into . “That just seemed kind of odd, given everything we had seen and
what we had concluded,” Gary Gorton, a Yale finance professor who had designed
AIG’s model for analyzing its CDO positions, told the FCIC. 
The CDO machine had become self-fueling. Senior executives—particularly at
three of the leading promoters of CDOs, Citigroup, Merrill Lynch, and UBS—
apparently did not accept or perhaps even understand the risks inherent in the
products they were creating. More and more, the senior tranches were retained by
the arranging securities firms, the mezzanine tranches were bought by other CDOs,
and the equity tranches were bought by hedge funds that were often engaged in
complex trading strategies: they made money when the CDOs performed, but could
also make money if the market crashed. These factors helped keep the mortgage
market going long after house prices had begun to fall and created massive expo-
sures on the books of large financial institutions—exposures that would ultimately
bring many of them to the brink of failure.
The subprime mortgage securitization pioneer Lewis Ranieri called the willing
suspension of prudent standards “the madness.” He told the FCIC, “You had the
