CDO STANDS FOR “COLLATERALIZED DEBT obligation,” and before the financial meltdown of 2008, hardly any nonspecialists were familiar with this arcane acronym. A CDO is a collection of individual debts (for example, home mortgages) that are bundled together in one investment pool. That pool can then be divided into different sections (or

“tranches”), representing different degrees of risk, and sold to investors. An individual lender, such as a credit card company, may put together a CDO, or an investment firm may create a CDO from a package of loans from different lenders.

Although abused during the housing bubble, CDOs perform a useful economic function. They allow lenders to focus on loan origination and investors to buy interest-earning securities.80 What serves no obvious economic function, however, are so-called synthetic CDOs, which represent a bet on the performance of a package of loans owned by others. For example, Goldman Sachs brokered a synthetic CDO, known as Abacus-2007 AC1, based on the performance of a group of subprime loans. But unlike a normal CDO, a synthetic like Abacus contains no actual bonds or mortgage loans; it......

Discussion Questions 1. Are synthetic CDOs a legitimate business investment, or are they pure gambling? If the former, what are their benefits? If the latter, should banks and other companies be allowed to wager on whatever they want if they like the odds and think they can make money that way?
2. In your view, what does the rise of synthetic CDOs tell us about contemporary capitalism?
3. Should synthetic CDOs be regulated in some way or even banned altogether?
4. Should Goldman Sachs have disclosed Paulson’s role to IKB and ABN? In not doing so, did it act immorally?
What obligations, effects, and ideals are relevant to answering these questions?
5. Did John Paulson do anything wrong? Explain why or why not.
6. As the top banks continue to get larger and larger, can small, community-oriented banks survive? Contrast the models of capitalism represented by the two types of banks. Where do you bank?