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.