(Circa Sep 21, 2008) Hey guys, I’ve had some interesting conversations with industry friends and colleagues over the last few days, and while we each foresaw trouble brewing as far back as 6 months ago, none of us predicted this…I honestly don’t think anyone from Bernanke to your average investor (me) did. This lack of clarity seems to have necessitated the following question:“Dude how’d we get here?”
On the train, at lunch, and in the gym this phrase (alright omit the dude) seems to be on everyone’s mind. While I’m no expert I take a shot at a simple explanation starting with a laymen’s breakdown of Mortgage Backed Securities (MBS), the investment at the center of this storm:
MBS at a glance
1. Bank A (IndyMac, CountryWide, et al) books 100k loan for customer
2. Customer buys new 100k home
3. Investor (Lehman, Bear, et al) purchases loan from Bank A at a premium, let’s say 110k
4. Investor chops up loan and sells to Counterparty (AIG, FF, et al) or keeps it
5. Customer pays back a total of let’s say 180k (principal and interest) over time
6. Bank A profits (10k) immediately from selling the loan at a premium
7. Investor and/or Counterparty profit over time from the 180k in mortgage payments
8. Customer profits by “owning” a house that belongs to the Bank/Investor/Counterparty
This, ladies and gentleman, is what they call a mortgage backed security, an investment that is secured by a mortgage payment (cash).
On its face an MBS is a sound investment instrument when the lendee can afford their mortgage, when they can’t…then not so much, as evidenced this week.
So the pop explanation you’ve all heard by now - banks were loaning money to people who couldn’t pay it back – is right on target. All the talk about CDO’s, leverage, Fed Funds Rate and Eurodollars are definitely relevant, especially now, but are symptomatic of number 1 on the aforementioned list…a bad loan. So whenever you hear complexity about how we got here, just think “a bunch of crappy loans.”
Where do we go?
I wish I knew exactly, I think in 12-18 months we will have put this behind us. Like you I’ve heard about the bailout plan but admittedly I will have to research it more in order to form a cogent opinion. At first glance I’m not excited about the prospect of congress just handing over absolute control of $700B to further bailout financiers (Bank A, Investor and Counterparty) unless we are CERTAIN there are ADEQUATE protections for you and me as well as significant upside or return on the 700B investment.
The good thing is Hank Paulson and his team over at Treasury seems up to the task. He seems to be measuring the situation with the proper gravitas and weight expected of a leader which is reassuring especially at a time like this.
The other good thing is that in addition to all the first in this election, that have elicited record excitement among the populace at large, we are also engaging, discussing and basing our decisions on more than just which candidate “We would most like to have a beer with.”
R or D I’ll take that kind of real involvement anytime.
rc
So the pop explanation you’ve all heard by now - banks were loaning money to people who couldn’t pay it back – is right on target. All the talk about CDO’s, leverage, Fed Funds Rate and Eurodollars are definitely relevant, especially now, but are symptomatic of number 1 on the aforementioned list…a bad loan. So whenever you hear complexity about how we got here, just think “a bunch of crappy loans.”
Where do we go?
I wish I knew exactly, I think in 12-18 months we will have put this behind us. Like you I’ve heard about the bailout plan but admittedly I will have to research it more in order to form a cogent opinion. At first glance I’m not excited about the prospect of congress just handing over absolute control of $700B to further bailout financiers (Bank A, Investor and Counterparty) unless we are CERTAIN there are ADEQUATE protections for you and me as well as significant upside or return on the 700B investment.
The good thing is Hank Paulson and his team over at Treasury seems up to the task. He seems to be measuring the situation with the proper gravitas and weight expected of a leader which is reassuring especially at a time like this.
The other good thing is that in addition to all the first in this election, that have elicited record excitement among the populace at large, we are also engaging, discussing and basing our decisions on more than just which candidate “We would most like to have a beer with.”
R or D I’ll take that kind of real involvement anytime.
rc
