Still, it appears that CDOs are back, see story below. Very likely the first ones will be relatively good, but if nothing else, the subprime crisis proved to me that either a) the financial community does NOT know how to assess their risk accurately, or b) this is a (legal) scam of the asymmetric-information variety--the issuer does understand the risk, but hopes that it has been successfully hidden from the "fools in Stuttgart" who buy them.
So, when one is looking through a Morningstar portfolio summary or a list of holdings, what would one look for to figure out whether a fund is dabbling in the kind of investments that blew up so spectacularly before? I'm sure they've figured out new and euphemistic names for them. Just looking for "mortgage backed" isn't good enough because of course there is are perfectly sound mortgage backed securities in the BarCap index, Total Bond, etc. (Larry Swedroe warns against them, but he's made it clear that he's talking about an incremental problem--a small amount of illusory outperformance that may one day suddenly become a small amount of underperformance--not a catastrophe).
I don't worry too much about the supposed "bond bubble" and interest rate risk, but I do worry about "cowboy bond manager risk", and I worry about it more in a competitive environment where bond earnings are low and managers may be tempted to distinguish themselves from the competition. This isn't a vacuous concern; see Schwab Total Bond Market SWLBX, Fidelity Ultrashort FUSFX, The Principal Inflation-Protected PIFSX, Oppenheimer Core OPIGX below. And note that Schwab Total Bond, although it wasn't strictly speaking an index fund, had tracked the BarCap Aggregate index just as closely as Vanguard Total Bond for fourteen years.
As for CDOs being back: NYT story, Wall St. Redux: Arcane Names Hiding Big Risk (If that link doesn't work, Google search on the title by clicking here and click on the first result.)
The banks that created risky amalgams of mortgages and loans during the boom — the kind that went so wrong during the bust — are busily reviving the same types of investments that many thought were gone for good. Once more, arcane-sounding financial products like collateralized debt obligations are being minted on Wall Street.
The revival partly reflects the same investor optimism that has lifted the stock market to new heights. With the real estate market and the economy improving, another financial crisis seems a distant prospect.... the revival also underscores how these investments, known as structured financial products, have largely escaped new regulations that were supposed to prevent a repeat of the last financial crisis.
“All of this seems like a fairly quick round trip,” said Manus Clancy, a managing director at Trepp, a research firm that focuses on commercial real estate. “You are seeing a fair number of sins being forgiven.”
Banks are turning out some types of structured products as fast or faster than they did before the bottom fell out....
....The structured product that has been the fastest to revive is the one that encountered the least trouble in 2008: collateralized loan obligations. These involve pools of loans given to companies with junk ratings.... banks have been able to loosen underwriting standards on the underlying loans and bonds. This provoked the Federal Reserve to release guidance last month warning that “prudent underwriting practices have deteriorated.”
....last year, revenue from securitizations was up 68 percent, according to the data company Coalition.
“Literally we thought the business was gone,” said Jeanne E. Branthover, a Wall Street recruiter. “The surprise is that this is a skill that banks are looking for again."