Category: Reddit Post

Mortgage and CDOs _ part 3 final | Trading Academy

Part 1 Part 2 This was not enough for American investment banks. It seemed simple: they didn’t gather clients but bought everything in bulk (on loans at 1% interest), the money from the monthly mortgage payments was flowing, everything was fine. But they came up with a new, even better earnings scheme. They decided: let’s resell these mortgage pools to Norwegian pensioners! To make them interested, let’s create a new structure: Collateralized Debt Obligations, CDOs. Secured debt obligations. Let’s issue bonds, secure them with our mortgage pool. Let’s divide the mortgages into more and less risky ones and create a pyramid out of them so that each Norwegian pension fund can acquire both profitable risky assets, as well as solid monthly payments. An investment bank creates a basket, for example, of a thousand mortgages, of which 500 are prime (white-collar workers and managers), let’s label them class “A”, 300 are subprime, class “B” (working people without higher education, service personnel), and the remaining 200 are high-risk, class “C”, meaning unemployed and financially struggling families who were given mortgages hoping they’d somehow manage to pay them off. And if they can’t — you can always kick them out into the cold and sell the house. Norwegian pensioners who bought “A” class securities receive their income first, but their interest rate is the lowest (for example, 5% per annum). Those who bought “B” class securities are entitled to 8% per annum, but they receive their income only after the thousand mortgages have accumulated five percent payments to holders of class “A”. There are also risk-loving grannies: they want to earn 15% per annum and buy “C” class securities — the ones with the highest risk. Some investment banks went even further (as if that was possible). They bought “C” class securities and divided them again: presenting you with bonds of “parking attendant”, “waitress”, and “limping old lady”! Then they packed it into a new pyramid, for the most reckless grannies from Oslo, promising them not 15%, but all 25% per annum, which is unheard of in Norway. In those times if someone brought money to a bank there, they didn’t give them interest, they took it for storage. And here they offer twenty-five percent per annum! Although the risk is enormous — how can you buy such a tangle of financial entanglements? Here’s how: it was enough for the seller to declare that the bonds were secured by mortgages. Technically, that’s what it was, but after diluting single malt whiskey with tap water, you understand… Still unclear? Well, the “The Big Short” movie explains it perfectly) In short, it’s enough for a few unemployed people to leave “McDonald’s” for a couple of months and sit down to play GTA, and the pyramid begins to crumble. There’s no tranche for the “waitress” class, which means the “C” class of the higher pyramid is left without payments. Then it turns out that Lehman Brothers took out a huge loan from Goldman Sachs against “C” class bonds, and Goldman considered this loan incredibly secure — firstly, Lehman always paid on time, and secondly, it’s secured by mortgages! And when Lehman suddenly couldn’t repay this loan, all of Goldman’s calculations went to dust, dragging down the entire financial gang. It’s important to understand that being angry at finance mechanisms is unproductive — it’s just technology, and it’s not to blame. You have to work out the technology and learn to apply it, then it will serve you well. You might just be wondering, what do Goldman and Lehman had to do with this?.. Just remember – It’s all cyclical submitted by /u/FXgram_ [link] [comments]

Mortgage _ part 2 | Trading Academy

It’s all cyclical. And far, far away in California, the unemployed people thought that home prices would only go up, and banks somehow thought the same – they gave out loans without any collateral. An unemployed person “bought” a house for $150,000 with no down payment, paying $700 a month. After six months, it turned out that the house was now worth $180,000. They sold it, bought a $200,000 house, using the virtual appreciation as the down payment. The bank was happy, the client was happy, and the real estate agent was even happier. It was only when every other borrower stopped making payments after a year, and the banks tried to sell the mortgaged houses, that they found out all the houses on that street were already on the market, and no one wanted to buy them for $180,000, $150,000, or even $100,000. And all because a couple of years earlier, banks had accumulated so much money that they stopped verifying the reliability of borrowers – why bother? Real estate was always appreciating! If they didn’t pay, we’d quickly foreclose at a round price. But mortgage banks weren’t satisfied with just getting clients. They wanted to earn more, and more importantly – faster. So, they started pooling mortgagees and selling them to investment banks. These are the banks that don’t operate on the classic “gather deposits – grant loans” model, but try to make money in more cunning ways. The mortgage bank sells thousands of loans to the investment bank upfront and immediately receives hundreds of oil or some trendy, but little-understood, commitments in return. submitted by /u/FXgram_ [link] [comments]

Mortgage _ part 1 | Trading Academy

It’s all cyclical. Before the depression, mortgage lending was on the rise. The typical loan term ranged from 2 to 5 years, with the principal repayment due at the end. What does this mean? If you were buying a house in 1920, you would go to the bank, and they would grant you a loan. Typically, they would provide half the funds. So, for a house worth $10,000 (equivalent to about $200,000 today, a modest home), the bank would loan you $5,000. You would pay interest monthly, and at the end – after two or five years – you would pay back the $5,000. Then you could try to get another mortgage. You’d go back to the bank, and they’d give you another $5,000. This was the scheme; banks offered it to everyone, and it became widespread. You’d pay only interest each month, and suddenly you’d have to pay back the entire five grand after two years. But people thought nothing of it – after two years, they’d just go back to the bank, and if they refused, they’d try another bank. I mean, who couldn’t find another $5,000 somewhere? And it all worked without major issues. What happened during the Great Depression? Two things: unemployment soared to 25%, and home prices plummeted by more than half. For instance, if you borrowed $5,000 for a $10,000 home, and it dropped in value to just $4,000, after two years you’d go to the bank to refinance the loan. You’d say, “Well, I’m unemployed, and my house is now worth $4,000.” The bank would respond, “Sorry, we won’t lend to you anymore.” What happens next? You have to sell the house, you go bankrupt, everything is lost. You’ve already lost the initial down payment of $5,000, and you still owe money. submitted by /u/FXgram_ [link] [comments]