Chris Haroun explains synthetic CDOs through a betting analogy: investors wagered on mortgage defaults without owning the mortgages, creating financial products based entirely on side-bets. These bundles of credit default swaps were sliced and sold like real mortgage bonds, but held no actual assets.
Love Selena Gomez. Bet you 50 million she wins and I'll give you a 3 to 1 odds.
3 to 1 odds. Okay, I'll take that bet. Now, the first synthetic CDO in her scenario is one woman watching her gamble by standing behind her saying, I bet 50 million bucks she wins. And another person saying, I'll take that bet at 3 to 1 odds. Neither of those better standing up own Selena's hands. Meaning the mortgage bond. They're just betting on the outcome. And in finance, this was done with credit default swaps. For example, investor A thinks the mortgage bond will fail and investor B thinks it won't. And they enter a swap just like Burry did with the banks. And that swap is essentially a synthetic position on the bond. Deadly. And a synthetic CDO packaged many such swaps together and tranched them out to investors just like a regular cdo. Except no actual mortgages were inside. Only the insurance contracts mean the CDS referencing the mortgages. And Selena's simple sentence. Now this is the first synthetic CDO signals. A synthetic CDO is born from these side bets on a real asset.
