As a general rule, wherever you find a large group of people who are baffled by complexity, you will find a smaller group of people making a good living screwing them. It's true with all complex things:  insurance, cell phone plans, legal stuff, technology, you name it. But it has never been truer than with the mortgage backed securities that are currently crapping down the throat of the global economic system.

As I understand it, a bunch of geniuses used something called math to make it seem like a good idea to loan money to people who are unlikely to pay it back. But here's the part I don't understand: Who invested in these risky securities?

According to a recent piece on 60 Minutes, there might be $50 trillion invested in these exotic financial vehicles. So why didn't anyone ever offer those investments to me? And why don't I know anyone else who invested in them? And why haven't I seen a crying widow on TV who wishes she hadn't invested her life savings in them?

As I understand it, banks and mortgage brokers offloaded their crappy mortgages to these investors, thus transferring the risk from the system that makes loans to a bunch of confused people who apparently ran out of regular things to invest in. So why is the banking system in trouble if they moved their worst loans to other people? And who are these other people?

Do you personally know anyone who invested in these exotic securities? And if not, how did we watch so much coverage of the economic crisis without learning such a basic fact?
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May 1, 2010
Great article,thank you for sharing.
<a href="http://www.1stchoicemortgageservices.com" rel="dofollow">Mortgage Services</a>
Oct 17, 2008
The problem is that the bad mortgages were bundled in with good mortgages and it was not possible to tell how much risk was embedded in the security.
Oct 15, 2008
Upon reading your opening line, "As a general rule, wherever you find a large group of people who are baffled by complexity, you will find a smaller group of people making a good living !$%*!$%* them.", I immediately thought:

'Organized religion'.

And then I thought- Dawkins and Myers would be proud.
+2 Rank Up Rank Down
Oct 15, 2008
Re: "fire your financial advisor" Easier said than done. It's a corp 401K plan with only a few selections to choose from; we do get some company match on this, however. As you point out in 10/15 post, I believe, "you think you are diversified, but you are not." Oh -- and the list of Top 10 Holdings for my plan includes 3 of Fannie Mae's offerings and also AIG --- Arrrgghhh! Luckily for me, I did not put ALL my eggs in the 401K basket!
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Oct 15, 2008

This is "The Subprime Primer"


Oct 15, 2008
Ahh, I work for a company that got horribly burned by investing in mortgage backed securties and had had to sell off a big part of the company to survive. The stock lost 95% of it's value. They bet the farm and they lost. It's clear the people buying this financial instruments did not understand them. The rating agencies who rated these investment items as solid securities don't understand them or the impact they would have.

They were outside of the regulations because of the uniqueness of the instruments. So many if's were built into them, that it was possible to have this happen. You toss in the credit swaps to insure the instruments and you have a bunch of non-existant money that only exists if people can no longer pay for their mortages, people who were stretched to buy mortages. So when the housing bubble popped we were screwed. The longer things went on this way, the worse it was going to be when things changed.

I suspect this was figured out by a group of mathematicians kept changed in dungeon of a financial company who are never allowed to see the light of day. Who forgot to mention "Oh by the way it only works if housing prices continue to rise and we increase the number of mortages/refinances we write per year by 10%."

The more I look at this with these tiered mortage backed financial instruments and the credit swaps, the more it looks like nothing more than elaborate Ponzi scheme. It was going to crash no matter what, it was more a matter of when. So instead of prison time the people who created this are losing their jobs, but they're wealthy.
The rest of us acquire debt on a national level, jobs loses, home loses and so on, This mortgage frenzy gave way to people seeing weath and tossing out morality and common sense. However, never mix morality and legality. Enough people exist on the edge or in the gray area of legality and exploit the loop holes for financial gain.
+1 Rank Up Rank Down
Oct 15, 2008
You don't get your news from the right sources if you didn't see what caused all this. Plus, according to the Wall Street Journal, the regulatory changes to prevent it in the future were made a couple years ago.

The issue was that the laws let the high risk loans be sold without labelling them as high risk. Rules are now in place to prevent that, but it didn't stop the backlash from the original issue.
+1 Rank Up Rank Down
Oct 15, 2008
Luckily in Britain our humourists are on the ball (well, some of them anyway) .. check out this clip .. it explains the Subprime Crisis in glorious comedy ..

Oct 15, 2008
Nothing is real. Imaginary money is invested in imaginary values until someone says out loud that the emperor is naked.

What really strikes me is that the whole system is based on trust. In a cruel world where everybody screws everybody, trust seem to be the weakest concept possible to base anything on. Trust in the value of mortgaged homes: that value only exists in the imagination of people who would (or rather wouldn't) buy these homes - that means you trust in the vague feelings of total strangers you never met.

Only idiots (sorry - induhviduals) would invest on such a basis, and since there are six billion of those, there are six billion answers to your question. If that isn't overkill, I don't know what is.
Oct 14, 2008
I saw either on David Ramsey or Suze Orman, someone who lost all their savings in Lehman brothers, which then offered him five cents on the dollar. The man said he tried to get his money out, but he said his financial manager wouldn't let him. He didn't really seem sure why they wouldn't let him get his money out.

I think that if you really don't have time to do much investing, you should start with bonds, F-DIC insured CD's, Ira's etc. and cover your butt at retirement age first. That's the route I'm trying to go.
Oct 14, 2008
As a former stock broker, I sold CMO's (Colateralized Mortgage Obligations) to individuals. There were also Freddie Mac securities, and there were Federal Home Loan Bank securities tied to mortgages. With the appointed Democrat criminal managers of Fannie Mae like Franklin Raines and Jamie Gorelic, this whole thing got out of hand. The entire world got screwed by buying these mortgage investments.

So, yes, there are lots of widows and orphans with these worthless CMO's and CDO's in their portfolios. There are also lots of widows and orphans with worthless Lehman Brothers bonds and notes in their portfolios. How about some jail time for the Lehman Bros chairman and the former managers of Fannie Mae?

We were all taken in by the socially appealing idea of affordable housing for poor people. We were all taken in by Fannie Mae.

Oct 14, 2008
In the 90's, I had an honest job in respectable division of Countrywide. One day a fellow cubicle rat explained about a small department that bundled loans and sold them as investments (I think the minimum size was 10 million dollars). I thought my friend must be pulling my leg, especially when he claimed that one little department produced far more revenue than the rest of the company combined.
Oct 14, 2008
You are so right. The more that is revealed about this financial crisis the less I understand it. I'm even beginning to wonder if money itself has any intrinsic value. Probably not - which is why I'm going to go out and blow all mine on hookers and drugs before the turnip becomes the new currency of choice.
+1 Rank Up Rank Down
Oct 14, 2008
@Grant in Virginia: The numbers get big because of something called "leverage". That basically means "borrowing money to invest". Follow the chain:
1. Person A sees people making money and decides to join in. Unfortunately, Person A has no money.
2. Person A realises that the interest earned on the investments is more than the interest repayments of a loan.
3. Person A borrows $$$ from a bank, and uses it to invest in sub-prime mortgages.
4. The bank packages Person A's loan up as a security which will pay interest as Person A pays interest.
5. Person B borrows $$$ from a bank, and uses it to invest in Person A's loan.
6. The bank packages Person B's loan up as a security which will pay interest as Person B pays interest.
7. Person C borrows $$$ from a bank, and uses it to invest in Person B's loan.
8. The bank packages Person C's loan up as a security which will pay interest as Person B pays interest.
9. Repeat previous two steps as desired.
n. The house price bubble collapses.
n 1. People start defaulting on their mortgages, causing Person A's investment to collapse.
n 2. Person A defaults on their loan, causing Person B's investment to collapse.
n 3. Person B defaults on their loan, causing Person C's investment to collapse.
n 4. Repeat previous steps until all the dominos have fallen.

Thus a single bit of debt can multiply itself greatly..
Oct 14, 2008
You're right, Scott. This is a complex issue. Let me try to succinctly trace it back for you:

Back in the Carter administration, the president sponsored and Congress passed a law called the "Community Reinvestment Act." This act added new regulations that required banks to revise their lending policies as they related to minorities.

In 1994, President Clinton had his HUD director, Henry Cisneros, to convene a meeting of private and public housing officials. Out of this came a document called the "The National Homeownership Strategy: Partners in the American Dream." It offered a number of ideas, most notably this one:

"For many potential homebuyers, the lack of cash available to accumulate the required down payment and closing costs is the major impediment to purchasing a home. Other households do not have sufficient available income to to make the monthly payments on mortgages financed at market interest rates for standard loan terms. Financing strategies, fueled by the creativity and resources of the private and public sectors, should address both of these financial barriers to homeownership."

The result of that committee was to supercharge the CRA, adding new regulations that virtually forced banks to give risky loans to mostly minorities and even illegal aliens (there are an estimated 5,000,000 home loans out to them). Failure to comply meant your bank might not be allowed to expand lending, add new branches or merge with other companies. Banks were given a so-called “CRA rating” that graded how diverse their lending portfolio was.

In the name of diversity, banks began making huge numbers of loans that they previously would not have. They opened branches in poor areas to lift their CRA ratings. Meanwhile, Congress gave Fannie and Freddie the go-ahead to finance it all by buying loans from banks, then repackaging and securitizing them for resale on the open market. That’s how the contagion began. With those changes, the subprime market took off. From a mere $35 billion in loans in 1994, it soared to $1 trillion by 2008.

Now, you may recall that a number of Clinton cronies, such as Franklin Raines and Jamie Gorelick became millionaires many times over from chairing Fannie Mae. They should be in jail, plain and simple, for the same reason that the Enron executives are. But they won't, because we have a Democrat Congress. Similarly, so should Barney Frank and Chris Dodd, who blocked any attempt to reform Fannie and Freddie, because their pals were getting rich and they were buying votes, calling the Republicans who called for reform 'racists.' But I digress.

The reason banks made these loans without documentation, employment or income verification, or even proof of citizenship, was because the government (read, Congress) assured them that Fannie and Freddie would buy them all. Which they did, over the protests of Republicans including George Bush and John McCain. But the Congress and Fannie/Freddie management justified this by saying that home prices would always go up, so they'd always have more in equity than the loan value. And if they didn't, there was always insurance (read, "AIG"), so there really wasn't any real risk, was there?

So, what did Fannie and Freddie do with the mortgages? Here's where it gets complicated, but bear with me.

Investment banks, who loaned the money, created a new type of security, called either a CMO or a CDO, using the mortgages as collateral. They created different classes of securities, depending on the relative risk of the attached mortgages, with interest rates reflecting the risk.

The classes (or Traunches, as they were called) were in effect called "good," "not so good," and "crappy." The promise was that investors would be paid, if some of the mortgages failed (or went into default if property values declined, but nobody thought that would happen), in order of which of the three types you invested in. Good got paid first, and so on.

Then, they went to insurance companies such as good old AIG, who insured the "good" tranches against loss. When the banks sold the tranches to investors, the securities had ratings from A to AAA, because of the insurance coverage.

This caused a buying frenzy, since millions of people who could never qualify under normal rules suddenly could afford home ownership. As those of you who can find your butt with both hands know, there is a basic economic principle called "the law of supply and demand." As demand went up ahead of supply, prices rose. Artificially.

The banks, using (this is more complex than we can go into here), the same accounting rules in a different industry that got Enron into trouble, didn't show the loans on their balance sheets. These were the same rules that our pals heading Fannie/Freddie used to pay themselves millions in bogus bonuses. But I digress again.

Suddenly, the bubble burst. The property values plummeted; low-initial interest rate loans ballooned; people started to walk away from their mortgages; the banks were getting little revenue from this bunch of sub-prime mortgages; the insurance companies did not have enough cash on hand to pay off all the bad mortgages that were suddenly looming on the horizon, and the house of cards collapsed.

But don't worry, it's only going to cost the American taxpayer about $1 trillion to stabilize the market. That's only about $3,000 per every man, woman and child in the US. No big deal. But that's an average, and as everyone knows, it doesn't work that way.

If you're one of the top 5% of wage earners who overall pay 53% of the taxes, your burden is slightly higher - about $57,500 each. But hey, that's the US tax system - fair, right? Especially since it makes the burden (or lack thereof) on the bottom 50% of tax payers go down to about $90 each. You just gotta love that tax system.

One final thing: before you start getting all weepy for all those poor minorities who lost their homes, remember this: most of them got in with no down payment, and had a very low initial mortgage payment for two or three years. In effect, they were getting to pay much less monthly than they would pay had they been renting an equivalent house. Sure, they had to pay property taxes and keep the house up, but with the tax break they got on their interest-only loans, they still came out ahead. So, when their mortgages were foreclosed, they lost very little and in many cases came out ahead. And now the government is going to make you and me pay to keep them in those homes at below what you or I would be able to pay for our home mortgages.

Whoever said life isn't fair didn't know the half of it. But this is what happens when government steps in and tries to force the free market to do something that doesn't make economic sense. Try to remember that when you vote next month.

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Oct 14, 2008
Oh, and the "exotic securities" were mostly credit default swaps, essentially insurance for the people that bought the mortgages. If you weren't already an investor, there was little reason to get involved in those. Once failures cropped up all over the mortgage industry, the insurance, which was covered by other people who were losing on the mortgages, suddenly needed paying. Since the mortgage-backed securities were used as leverage, once they started to lose value the banks' balance sheets took pretty big hits. The fastest way to get back to a good position was to dump the bad assets, but since every other investor was dumping at the same time, they became completely worthless and the balance sheets got even worse.

I'm still not clear on the math that made credit default swaps seem like a good idea, but I'm sure it seemed great at the time.
+1 Rank Up Rank Down
Oct 14, 2008
Over here in New Zealand, almost 20 finance companies failed over the past year or so, affecting a few hundred thousand people, including grannies who lost their life savings, mums who'd invested money to pay for their disabled son's holiday, etc. A few hundred thousand people is a pretty big deal here. I don't know, but I'm guessing those finance companies were investing in sub-prime mortgages and other junk.
+1 Rank Up Rank Down
Oct 14, 2008
The short answer is that they were bundled into groups of 1000, so they weren't available to average investors. They were bought by investment banks as a safe alternative to stocks and a more lucrative investment than bonds (particularly since interest rates have fallen so far -- which was also a cause of the glut of mortgages). They were considered safe because defaults were mostly backed by the GSEs, which everyone assumed meant an implicit government guarantee.
0 Rank Up Rank Down
Oct 14, 2008
Thanks to Awallace for recommending that "This American Life" radio episodes. Best and clearest explanation and investigation I've seen anywhere.
0 Rank Up Rank Down
Oct 14, 2008
I second the comment about "This American Life." I recently listened to both hours. It was well worth the time.
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