Have you heard of CDO? Hardly anybody knows CDO unless a seasoned investor. But if you read articles on business lately, you may stumble upon this word. CDO stands for collateralized debt obligation. It's a very tricky invention that allows bankers to make money off of bad loans. A CDO package is created by packaging high risk loans — mortgages given to people with low income and bad credit — and good loans together into a high interest investment package so that banks can sell the CDO package to gullible investors or another bank. This way, banks can get rid of risky baggage off their books and make money at the same time.
CDO's are supposed to guarantee earnings even if some of the loans go bad. But in the past year, most of the mortgages that make up CDO's went default. Malfunctioning CDO's are the main reason why many big banks have crumbled.
Here's a nice presentation of CDO by portfolio.com.