Some details are coming out as to how CDOs were valued by financial institutions. It seems that credit ratings were a key factor in determining value. The institutions compared the value of similarly-rated securities (e.g., corporate AAA bonds) in the marketplace. They would then value their AAA-rated CDO based on the value of corporate AAA-rated bonds.
There was one small problem in this valuation process: 90% of CDOs were rated AAA by Moody's etal, yet far fewer than 90% of corporate bonds were rated AAA.
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