I recently watched The Big Short and had some trouble understanding the whole CDO Manager thing.. Who was that guy? I didn't understand what they were talking about and how did Mark conclude that the world economy was going to crash after talking to the guy?
It's perhaps a little clearer from the film's script. These are the key phrases
MARK: Are you worried about rising default rates?
MR. CHAU: I assume no risk for these products myself.
MARK: Okay. This is a pool of, say, 50 million in subprime loans. How much money could be out there betting on it through these synthetic CDOs and swaps?! Right now?! Tonight?!
MR. CHAU: A billion dollars.
MARK: CDO A has parts of CDO B and CDO B has parts CDO A, but then both get put inside CDO C?
MR. CHAU: That one's called a CDO Squared. And then there are CDOs made up of the opposite side of the bet you made with your swaps. We call them synthetic CDOs.
So, we have a CDO Manager whose job it is to manage nearly the GDP of a small country, but who has zero interest in assessing the real risk of what he's buying (e.g. the risk that the mortgages might go into default). We learn that CDO managers around the country are betting many multiples the value of the blocks of mortgages on their continued survival and we learn that the CDOs (many of which contain garbage mortgages on the verge of default) are overlapping with each other.
The ultimate upshot of this conversation is that if one CDO fails (if even a few hundred mortgage holders default on their mortgages), it will take down the entire swap. Not only that, but the CDOs are worth billions, riding on the actions of homeowners who've been missold dodgy mortgages.
From the real court case against Mr Chau:
The SEC has charged Chau and Harding Advisory with allowing hedge fund Magnetar Capital LLC to have undisclosed influence over the selection of collateral for Octans I.
According to the government, Magnetar played a role in the deal despite its known strategy of taking short positions on mortgage-backed securities in CDOs, including ones it was investing in, as it was in Octans I.
Basically Chau was being paid for guidence in building the CDOs, but was employed by a company doing their own short against them, a conflict of interests.
What Baum also realised was as the CDOs were repackaged they became a giant web, and once they started to fail the whole lot would go.