CDO's

In explaining the huge explosion of Subprime Mortgages , you need to follow the instrument that has fueled the surge . That is the CDO ( Collateralized Debt Obligation ) , a derivative constructed from a variety of debt instruments , in this case mortgages ( RMBS--- Residential Mortgage Backed Security ) . The instruments are packaged , through "financial engineering " , into a tradeable security which banks , brokers and hedge funds can use to invest and/or hedge their debt portfolios . The more profit these instruments make the brokerages and investment banks , the more were sold to investors .
It's not just Mortgages which are packaged into CDO's , so are the debt tranches of the LBO's and MBO's so prevelant in the Private Equity world . Without such innovative instruments , there wouldn't be as much merger activity as we are now witnessing . For better or worse , these instruments will be here to stay