Collateralized Mortgage Obligation (CMO)

Collateralized Mortgage Obligation is mortgage backed securities pooled together, and divided them into A, B and C three levels by using their credit levels. securities with highest credit will form into A level, and then B level, and securities with the worst credit level will go into C level. When receive repayment, the money will flow into A level first, like a pool of water, when the A level is full, the money will overflow from A level and flow into B level. When B level is full then money will flow into C level.

For example:
Mortgage brokers will collect mortgage loans from banks, and make these mortgages into A, B and C three levels. broker will sale these packages separately with different prices. A level will have the highest price because it has the lowest risk to get the money back. When brokers sold these mortgage to others, this means the risk to get bad debt is allocate to those people who brought the package.

When economy is good, all these people who brought the package will get money back from borrowers, however, when in a bad economy, there is a very high chance to get a bad mortgage. People will loss money.