BAD LOANS: Buried In The Back Of The BreadBox
“Mortgage backed securities (MBS) were originally the old Ginnie Mae pass-through certificates. The VA or FHA packaged up their loans and sold them through Wall Street to little old ladies who wanted to “juice up the yield” on their portfolio. They were safe because they were backed by a government agency. They yielded more than treasuries because they were a conglomeration of various mortgages. The money was loaned at, oh… 14% (remember the early 80’s ?) and the investors received, say…12%. It was a good deal because the little old lady could only get 9% on Certificates of Deposit. The difference was spread among loan servicers, Wall Street, and even the gub-a-mint agency by employing this securitization tactic.
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An ambitious mail-room clerk named Lew Ranieri worked at Salomon Brothers and saw an opportunity in the mid 80s. Salomon Brothers was hiring rocket scientists to create a new breed of mortgage-backed security, a collateralized mortgage obligation (CMO), designed to more accurately predict the prepayment speed of the mortgages backing the bonds they sold. Lucky Lew ran around the country preaching God, motherhood, baseball, and a CMO in every portfolio. Lew convinced the WORLD investment community that the American homeowner was a damn good bet.
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Fast forward to 2001. A little mortgage broker from New York grew into one of the largest lenders; Countrywide. He, among others, understood the power of the MBS market and started designing new mortgage products. He, among others, understood that if you loosened the guidelines a LITTLE BIT, you could add one quarter to one half percent to the rate and whet the appetite Wall Street had for yield. Something was about to happen that would have the Wall Street Titans begging the little mortgage broker for more mortgages with the guidelines loosened just a LITTLE BIT.