CDO

Felix Salmon overview of CDO creation with over-collateralisation.

But what happened over the past few years was that demand for those AAA-rated CDO tranches went through the roof, and it became harder and harder to find a nice diverse universe of BBB-rated bonds to throw into the cauldron. As a result, the ingredients getting thrown into the cauldron started getting less and less diverse, until it reached the point that all, or nearly all, of them were, in some way or another, ultimately reliant on subprime mortgage payments.

Risk and liquidity

FT.com
looks at the way the the move away from risk has affected liquidity in markets like the US treasuries and European bonds.

"Indeed, even in the US Treasury market, the spread between buy and sell prices for securities issued by the Treasury before the current quarter has become a lot wider than normal. “Traders and banks are in risk-reduction mode,” said Tom di Galoma, head of Treasury trading at Jefferies."

There is a higher price to pay and a wider spread.