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Fischer, Noelle
Mr. Marshall
Economics Block E
27 November 2015
Where Did We Go Wrong?
Gas was going up. People were losing their jobs. Many houses were being sold or
becoming foreclosed. Many people wondered if the country was entering another depression.
The question what were the factors that caused this circled the country, adding to the mixture
of confusion and chaos. From the meltdown of 2007 only a few people fully understood the
factors, until now. Factors that make a satisfying answer to the essential question are the
innovations of CDOs and CDS, the events that occurred from the creations, and the effects of
how the CDO and CDS were incorporated by each company.
The first place to start the investigation, the idea of events that occurred connected by a
red string, is to find what all the corporations had in common: synthetic CDOs and CDS. In order
to understand the first factor, synthetic CDO, a basic understanding of CDO must be known.
CDO is an acronym for Collateralized Debt Obligation. Collateralized Debt Obligation is
structured asset-backed security. This was originally developed for the corporate debt markets.
Lloyd Blankfein, Goldman Sachs CEO & Chairman, describes CDO as a pool of assets that are
pooled together and then sliced into many pieces. In a synthetic [CDO], the pool reference
securities that are indexed to specific more pools of mortgage (PBS). The creation of the CDOs
led to the creation of CDS, the credit default swap. The creation of the CDOs and CDS spread
like wildfire among the banking businesses.
It is difficult to identify the origin of the crisis, but it is evident that a JP Morgan
conference held in Boca Raton, Florida, meant for relaxation, was the turning point for the crisis.

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Gillian Tett, author of Fools Gold, described those who attended, as young, mostly in their 20s .
. . full of high spirits, they did what any young bunch of kids would do and got drunk. The
characterization of attendance has a bad connotation. The attendees gathered in order to find a
solution to reduce risk. The risk that was being considered at the conference was insured
money that a bank must hold in that location. This was established by the FDIC, under the
authority of the Glass-Steagall Act. But at the conference, the JP Morgan employees were
thinking about how to manage the risk but still making a profit for the shareholders and to think
of the effects of their innovations. Gillian Tett stated that they looked for a way to pass the risk
between them. The solution: sell the loans. Although this was a solution, the creators investigated
for a way to completely separate the risk of a loan from the loan itself. Soon, Credit Default
Swaps (CDS) were developed.
The next idea to examine in our investigation is Credit Default Swaps, which are based
on the logic of derivatives. Credit Default Swaps are similar to derivatives, in that they insure a
loan against default. Derivatives created a way to be on a future value of something. The credit
default swaps created a door to reduce risk- the exact door that JP Morgan was looking for. The
JP Morgan team realized that credit derivatives could be used in order to trade loan risks. The
swaps allowed companies to shed the risks that they don't want to take and to take on other,
better risks. Gillian Tett described this as borrowing one set of ideas for the commodities market
and applying it to loans for the first time. This idea was essentially created under the banner of
making the financial system safer. Banks got insurance on their derivatives as a safety net if
one account were to flop. JP Morgan thought that the CDS would make the system safer, when in
reality, the CDS allowed the system to be abused. The CDS were designed to repel the Glass-

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Steagall Act. The repelling of the act would create a way to evade regulation. The CDS were
designed to not be regulated. This is the exact turning point which turned the economy.
Bankers believed that the higher the risk, the better investment. Subprime lending rose to
popularity. Subprime lending was a market that was normally avoided and meant for people
whose credit was inferior. Frank Alexander, a graduate from Emory Univ. Law School, stated
that the subprime market was originally a niche market, not for the major banks, but for
mortgage brokers who were specialists in this market (PBS). The turn of the subprime market
was that the subprime could now be secured and sold on Wall Street in bundles to make a higher
yield. The Moody declared the subprime market AAA, or a low risk.
All these factors were evident in Atlanta, Georgia reality. It was reported that Subprime
loans in Atlanta jumped by more than 500 percent during a five-year period (PBS). The
economy was strong and home buyers were willing and able to spend double of an amount on a
house. The reality system became very, very loose. Soon, more and more mortgages were being
created and taken out on other mortgages. The mortgages were a sign that the loans were greater
than the value of the house itself. The mortgages are another event that the red string points to
in our investigation and leads to the IKB.
The IKB was a company in Germany that believed they themselves were one of the
strongest banks and constantly made it known that they were smart investors. The IKB bought
many subprime mortgages. It was recorded that Americans were buying real estate in record
numbers which totaled the credit default swaps to measure in trillions of dollars that doubled
every year. Soon the economy could not keep up and the irony of IKB hit when the subprime
mortgages caused IKB to fail, in July of 2007, which caused other businesses to fail too. Soon,
one insurance company owed 44 billion dollars because they insured in CDOs. Soon, houses that

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were created in the new system foreclosed and were abandoned. The banks didnt want to lose
any more money than they already did, so the banks kept the foreclosed house to be empty in
wait the economy would turn in order to put the house back on the market. However, the
foreclosed houses in communities caused a rise in property taxes which pay for the local
education. The foreclosed houses also brought down the property value of the house. It was only
a matter of time before the Main Street would reach Wall Street.
The effects were like an iceberg. The CDS is the top of the iceberg. The destruction and
pandemonium effects of the CDS are the ice that is hidden in the water. No one expected the
great idea of CDO and CDS to cause major destruction to not only Main Street but also Wall
Street and Global Street. At the time, the repercussions of the innovations were far from being
discovered. Data and records of the late 2000s shows that no one fully understood the problems
CDO and CDS would cause. The red string that was connected events, innovations and ideas
throughout the whole investigation of what caused the meltdown in 2007 all point to the
creation CDO and CDS by JP Morgan new young, mostly in their 20s, full of high spirits that got
drunk in Boca Raton.

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Source Used
"FRONTLINE: Money, Power, Wall Street." PBS. PBS, Corporation for Public Broadcasting,
John D. and Catherine T, MacArthur Foundation, Park Foundation, The John and Helen
Glessner Family Trust, Ford Foundation, Wyncote Foundation, FRONTLINE Journalism
Fund, Jon and Jo Ann Hagler on Behalf of the Jon L. Hagler Foundation, n.d. Web. 27
Nov. 2015.