At a packed hearing today on the 2,200-page autopsy of Lehman Brothers, a painstakingly detailed report by bankruptcy examiner Anton Valukas, Treasury Secretary Tim Geithner was asked about a obscure yet destructive financial product called a collateralized debt obligation (CDO). In particular, the questioner, Rep. Joe Donnelly (D-Ind.), wanted to know Geithner’s take on “synthetic” CDOs, which are complex derivatives whose value rose and fall depending on the swings in the housing market. (That allegedly rigged Goldman Sachs deal at the heart of the SEC’s suit? Yep, a synthetic CDO.) Unlike regular CDOs, which are backed by pools of actual mortgage loans, synthetic CDOs take the gambling to a new level: They’re not backed by actual loans at all. Instead they were created by Wall Street’s rocket scientists when the stream of real loans ran out to fulfill the demand from investors clamoring to bet more on the housing market.
You’re probably asking, What do synthetic CDOs mean to me? Well, other than helping to explode the economy, not much. In fact, there’s been considerable doubts and hand-wrining on whether these products serve any purpose whatsoever. “With a synthetic CDO, it’s a pure bet,” Erik F. Gering, a former securities lawyer and now a law professor at the University of New Mexico, told the New York Times. “It is hard to see what the social value is—it’s hard to see why you’d want to encourage these bets.”
Back to Geithner. What Rep. Donnelly asked the treasury secretary was this: If they’re essentially explosive poker chips that helped topple the economy, do we need synthetic CDOs? Should we get rid of them? To no one’s surprise, Geithner wavered. He vacillated. While he admitted that the logic fueling the rise of synthetic CDOs before the housing crisis—that the market would grow and grow and never stop—was horribly wrong, he chose not to disavow these products that have little, if any, purpose apart from speculative investing. “They do provide a useful economic function,” Geithner said. Whether that function benefits anyone other than the people in the casino remains to be seen.