Circular CDOs: Contagion in the Financial Industry

The recent financial meltdown had many culprits. To make matters worse many of the investment banks bought and sold suspect mortgage securities with each other. The cross-ownership of securities, based on failing mortgages, increased the speed and the breadth of the collapse.

We obtained CDO cross-ownership data from this ProPublica page: Interactive: CDOs' Interlocking Ownership. By putting this data into our network analysis program, InFlow, we performed additional diagnostics. ProPublica focuses on CDO: Tabs 2007-7 because it has the most cross-ownership links. We know, from 20+ years of doing network analysis, that the number of links a node has may not matter -- it is where those links lead that matters! After all, the golden rule of networks is "Location, Location, Location" and not "quantity, quantity, quantity." Applying contagion principles, we learned while working with the Centers for Disease Control [CDC], it is revealed that the following CDOs are much more likely to infect the rest of the network if they contain failed securities: GSCABS CDO 2006-2 MLTD or West Trade Funding CDO I.

( You need to enable Java to see this applet. )

The network map above shows the intersecting ownership of CDOs. The green nodes are investment banks, and the blue nodes are the various CDOs involved in cross-ownership. We have data on three networks (link sets). We have Bank-CDO data to show which bank owns which CDOs. Next, we have CDO-CDO data which shows which CDOs sold mortgage securities to each other. These two sets of data were provided by ProPublica. From this data we derived the Bank-Bank network based on which CDOs a pair of banks intersected on.

You can interact with the map above by dragging nodes on the screen and by choosing which Nodes and Links you want to view from the panel on the left. To watch the network self-organize, in front of your eyes, click on Random and then Auto -- you can move nodes with the mouse as the map is self-organizing, or after it is done. To stop node movement, click the Freeze button. More visualization choices are available via the View Options button at the bottom of the left hand panel. To get back to the original visualization, just click the Reset button in left side panel. Enjoy!

We thank for the CDO data.

Copyright © 2010, Valdis Krebs

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