CDO is a term that sophisticated investors talked about but I doubt many really understood. If you had asked 100 retail investors a few weeks ago if they had heard about CDOs, I am guessing about 10% might have said yes. But if you asked any of those ten if they knew what CDOs are, I suspect only one or two would come close. When we are not aware of something, we are not capable of being afraid of it. When we become aware of something that we do not understand - that is when fear sets in.

Now the situation is changing and everyone is hearing about these financial instruments and yet, I am not so sure investors are benefiting from trying to get out of their ignorance. CDOs are extremely complex pools of risk that have been like a giant junk drawer for credit risk that no one wanted to price. Some estimates have the CDO market at about $1 trillion dollars, but given that they are derivatives, the real impact on the underlying assets they are tied to is much higher. And remember that there are many forms of CDOs, not just mortgage backed. So I am extremely concerned that the lack of previous familiarity and the complexity of CDOs will cause investors to overreact to what they do not understand.

As I expected, Bear Stearns and Merrill found a way to temporarily avoid a huge meltdown from the marking to market of these products. But what has been exposed in the process is extremely threatening to almost every aspect of the markets and now that the genie is out of the bottle, it will be tough to shove CDOs back into the junk drawer or under the rug. CDOs are too complex for people that are not investing in them and the majority of investors don’t play in this game. So when they hear that CDOs are a threat to their assets, it’s a dangerous situation.