This article contributes to the legal theoretical foundation of the regulation of structured notes. We shall first anatomize the most typical kind of structured note, the collateralized debt obligation (CDO). We analyze the similarity between a CDO and a constructed pledged mortgage, point out the embedded fuzzy information behind this structured mortgage, and then identify the implicit externality of this mortgage construction. We argue that CDOs can be treated as properties instead of contracts, and the usual notion of numerus clausus does support more severe regulations on such properties. Most existing literature has emphasized the moral hazard problem of investment banks which packaged and sold these structured products. The implications are naturally to increase the capital adequacy ratio, and to impose partial liability on the banks in the event of defaults. What we demonstrate in this paper is the intrinsic externality and information deficiency associated with CDOs. We show that the feature of prioritization associated with the structured debt makes the disclosure of information of CDOs intrinsically difficult. More importantly, the fuzzy information is actually created by the issuer of CDOs, which suggests a rationale for government intervention.
- structured debt,
Available at: http://works.bepress.com/cyrus_chu/2/