Why Are CDOs and Structured Notes Making a Comeback?

From a regulatory standpoint, it seems ironic: collateralized debt obligations, or CDOs — the products at the heart of the financial crisis that failed in spectacular fashion — are back. Even more ironic is that CDO-like products also failed when the tech bubble burst around 2001. Before that, their emerging market structured note cousins failed during the Tequila crisis that began in Mexico in 1994-95 (and by the way, emerging market structured notes are back, too).

This repetition, of course, brings the caveat emptor cliché to mind, or in lay parlance: “Fool investors once, shame on the investment banks; fool investors three times, shame on the investors.”

CDOs and structured notes are a subset of the products conceived by the industry broadly known as “structured finance,” which is otherwise a great invention because it’s here that many risk management solutions arise. If you have a risk you want to manage (e.g., earthquakes, floods, hurricanes), structured finance can provide the solution, because, when it works, it provides a way to replicate the risk you don’t want to take so that you can offset that risk, for a price.

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