Business: Recipe for a mortgage mess

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Recipe for a mortgage mess

By HELEN HUNTLEY, Times Personal Finance Editor
Published September 6, 2007

The "cooks" on Wall Street created asset-backed securities that were in big demand until a few months ago when mortgage defaults threw their fancy financial masterpieces and the stock market into turmoil. Suddenly the diciest of these securities could no longer be traded because nobody was sure how much they were worth. Hedge funds that owned them were forced to sell stocks and other investments to meet redemption demands. Here's how the Wall Street chefs created those securities:

1. THE INGREDIENTS

Put up a little bit of your own money

Borrow a whole bunch more

Use it to buy lots of loans: mortgages, credit card debt, car loans, home equity loans and other receivables.

2. MIX IT UP

Mix loans together in one great big trust.

Confer with bond rating agency to get your recipe just right so your securities will carry good credit ratings.

Design your securities, which represent rights to cash flow from the loans in your trust.

3. THE NOT-SO-TASTY RESULT

Sell your securities to investors, many of whom borrow money to make their purchases.

Make payments to investors. Those who bought the top layer get a AAA rating and first dibs on the cash flow, so you give them the lowest interest rate. Each succeeding layer is riskier, so you have to pay a little better rate.

Make money on the difference between the payments you receive on the loans in your trust and the payments you have to make to investors or to the banks that lent you the money when you started cooking.

Watch loan defaults threaten your creation with collapse.

Source: Staff research

[Last modified September 6, 2007, 00:21:46]

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by Mark	09/06/07 07:55 PM
Harry tells it like a true democrat. Blame someone other than those responsible. In a free market society, funds do what they want, or is your memory that jaded with politics. This is not a new phenomenon, but one that has been around for ages.

by AJ	09/06/07 05:58 PM
This is simply a legalized pyramid scheme dependent on a constant injection of new capital i.e. pension funds, 401k funds,unwary investors. Music stops,wait to see who is left holding worthless paper. Overvalued paper currency, the US biggest export!

by AJ	09/06/07 05:58 PM
This is simply a legalized pyramid scheme dependent on a constant injection of new capital i.e. pension funds, 401k funds,unwary investors. Music stops,wait to see who is left holding worthless paper. Overvalued paper currency, the US biggest export!

by bernie	09/06/07 05:40 PM
I am a mtg. prof and this article confirms what i have been saying: Wall st is the culprit,not subprime borrowers. 2 yrs ago, a 30 yr fix was 1 pt higher than a 2 yr arm.Pepole chose the cheaper beleiving credit would get better,values would rise.NO!

by Harry	09/06/07 11:50 AM
The only thing "smellier" than this concoction is the scent of a good-old, Republican-stock-friendly Bail-Out- encourage risky lending, print cheap money, de-value our dollar, then reward it- another Bush/Neo-Con legacy- hope it was worth it guys!

by Heidi	09/06/07 11:42 AM
Very good explanation with illustration. Makes the problem understandable.

by cleo	09/06/07 09:21 AM
"GREED" IS GOOD* *Greed can be Bad if there are too many players

by Sean	09/06/07 04:21 AM
Forgot Step 4: call senators and presidential hopefuls to whom you've made HUGE contributions and ask for a BAILOUT to help "working families" where Fannie buys your bad loans at top dollar. Does Fannie foreclose too, or just send a letter?