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I read somewhere that before the financial crisis of 2007 the financial instruments (CDOs) were so complex that the investors could not analyze them. Were they just complex or was there no public information about what they contained?

Also, in The Big Short movie Michael Burry analyzes those CDOs before deciding to short them. Where could he get such information?

  • Also given that there are many books/articles on the topic, you should start there. Also CDOs are not available to retail investors so is off-topic for this site. Please see:What is On-Topic? – Morrison Chang Aug 19 at 17:14
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    Off topic? CDOs affected almost everyone's personal finance in 2008-2009. – Bob Baerker Aug 19 at 17:25
  • @BobBaerker While the effects of the Great Recession touched everyone, OP's question is about where did 'they' get the CDO information, not directly linking how that relates to personal finance. And as you've mentioned in your answer - "read the book", but if the community thinks its valid, my comment is moot. – Morrison Chang Aug 19 at 19:20
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People decided to short CDOs by noticing the base components of a CDO, which were a significant portion of highly leveraged debt, existing delinquencies that reinforced the peril of highly leveraged debt, probable delinquencies, and the high credit rating of the CDO itself.

These people either had solid information - like information of the CDO components - or they had probable information. Like the mortgage industry is probably overleveraged and this is the best product to get exposure to it.

So this answers both of your questions. CDOs didn't have the best transparency, some people had transparency, and some people inferred it from enough sources. It is also further important that only some people cared to look. Mortgages as a path to homeownership was seen as an industry that was untouchable by the business cycle, houses went up in price and nobody would readily agree with the contrarian view.

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CDOs are so complex that even the quants at investment banks and financial institutions weren't able to properly assess their risk. Look how many banks as well as investment banks went under. On the IB side, Merrill Lynch? Bear Stearns? Lehman Brothers? It also didn't help that there was collusion by the ratings agencies.

As for Michael Burry, my guess is that his success was more of a macro assessment of the big picture, realizing that coupled with the frenzy of leverage home buying, a housing bubble was imminent and the deterioration in the the lower trenches of CDOs were an accident waiting to happen.

As for the movie, The Big Short, if you want a better understanding of it all, read the book. The movie was a dumbed down version for the general population that has a minimum of financial literacy.

  • Is the first sentence missing a not somewhere? – Lawrence Aug 19 at 20:35

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