Collateralized debt obligations (CDOs) are a type of asset-backed security and structured credit product. CDOs are constructed from a portfolio of fixed-income assets. CDOs are divided by the issuer into different tranches: senior tranches (rated AAA), mezzanine tranches (AA to BB), and equity tranches (unrated). Losses are applied in reverse order of seniority and so junior tranches offer higher coupons (interest rates) to compensate for the added default risk. Since 1987, CDOs have become an important funding vehicle for fixed-income assets. With the advent of the 2007-2008 credit crunch, there is increasing concensus that CDOs, like all asset backed securities, suffer from a fundamental flaw that causes them to be extremely high risk for investors - loan originators retain no residual risk for the loans they make, but collect substantial fees on loan issuance, which causes unchecked degradation of underwriting standards. This problem was exacerbated by the failure of credit rating agencies to take into account the collapse of underwriting standards when valuing these products. The institutions buying CDOs relied on the ratings agencies, as they lacked the competency to monitor credit performance and/or estimate expected cash flows. Major loss of confidence has now occurred in the validity of the process used by ratings agencies to assign credit ratings to CDO tranches and this loss of confidence persists into 2009. http://en.wikipedia.org/wiki/Collateralized_debt_obligation

Not really. Nor Moody's or the rest of the pack. Our rating agencies left us down and our SEC wasn't on the job either.

Frankly I have never trusted such ratings because first, the bases of those ratings are very subjective and relative, and second, I don't quite understand how S&P comes up with those ratings anyway.