ECONOMY: Toxic securities, where did they come from?

A quick word about SECURITIZATION and how it got financial institutions in trouble when securitization turned TOXIC.

Simply put, the 1970 financial tool invention bundled assets that produced a cash flow (mortgages) into securities called “asset backed securities” ; securities / bonds backed by actual homes / buildings. These financial instruments were also called “collateralized debt obligations” CDOs - I hope you get the picture.

It is better to explain this with an example.

In the old days (pre-1970) banks made loans (mortgages) to home buyers for a specified interest amount and held those loans until they were paid off (30 years). The bank made a profit off the interest it collected which usually amounted to quite a sum. Obviously, the banks wanted to make sure they got their principal and interest back so they made sure the borrower was and would be able to pay the mortgage off without trouble and that was why it was so damn hard to get a loan in those days.

After 1970, led by government example (Ginny Mae/Freddie Mac) some banks were taking a bunch of these mortgages and pooling them into a single, lets call it a BOND or SECURITY which they then sold to investors as shares in a cash flow producing, asset backed investment.

This financial instrument delivered a number of benefits for the bank. The bank would get its original principal investment back together with a small interest profit on top of the fees the bank charged to originate the mortgage. So the bank made a smaller amount of money than if it held the mortgage to maturity (30 years) but it got the mortgage off its books which freed up funds to make more loans with. A bank could do very well if it had a high mortgage loan turnover.

The investors buying shares in the asset backed security or CDO would get a steady stream of money (cash flow) which consisted of the monthly principal and interest payment minus a small servicing fee to the institution collecting the money. Since these securities were backed by hard assets (homes), they were considered extra safe because, after all, real estate in America always goes up and up in price.

If you’re a long time mortgage payer as I am, you will remember how your mortgage would get sold to some other institution and you had to send your payments to a new address. Sometimes my mortgage was sold days after I signed on the dotted line; a million times.

I guess, at the beginning and for many years after that, mortgage securitization made a lot of sense and benefited the regular guy on the streets by making more money available for home loans in general and secure investment securities for investors.

As bank and lending regulations became softer and softer, trouble was bound to follow. Please remember that it was our government that believed “EVERY AMERICAN SHOULD OWN HIS /HER OWN HOME”; It is the American dream so by golly, lets make the dream come true.

The hard reality we now know is that some Americans can never own a home and should never be allowed to own a home BECAUSE THEY CANNOT AFFORD A HOME AND PROBABLY WILL NEVER BE ABLE TO AFFORD A HOME.

Do you remember the time when you did not have to go to a bank to get a home loan but could go to all sorts of places (non-banks) that offered home loans and get really good deals that you could never get before and the deals kept getting better as time moved on?

I can also remember when friends and neighbors were quitting their regular day jobs to go into mortgage writing (originating); it was a hot field to be in.

All you had to do is find someone wanting to buy a house or re-mortgage an existing home, do the paperwork and sell the mortgage to an investment house who would bundle these mortgages into securities and sell them as shares which could also be split and resold. The loan originators made their money on the sale of the mortgage so the more loans they could close, the more money they would make.

The path to becoming rich was to write as many mortgages as possible. This mad rush to write as many mortgages as possible because someone was waiting to buy them from you eventually degenerated into writing BAD loans or loans to people that did not qualify. The rationale behind giving loans to people that did not qualify was that at least, there was a hard, valuable asset (house) backing the loan which could always be sold to recoup money from bad loans.

To understand the ENORMITY of this SECURITIZATION world we are told that in the United States alone, asset-backed securities now total 10.2 TRILLION DOLLARS with about 2.5 TRILLION sold overseas. Let me write a trillion out so you can see:
$1,000,000,000,000.

When people started defaulting on their home loans as was inevitable, the cash flow started stopping and because so many people were in foreclosure and there were so many homes on the market, the long term rise in real estate prices leveled and then started coming down.

As our economy soured and more and more people lost their jobs and with that their ability to pay their mortgage obligation, more and more homes were abandoned, flooding the market making home prices fall even lower BUT no one was buying because they were afraid of what the future may hold and were going to just sit on any money they had.

What about the trillions of dollars worth of asset backed securities in investors hands that now were not producing a cash stream AND could not be sold to anyone because their value was undeterminable.

Because mortgages were BUNDLED into securities that issued shares; it is hard to actually find who or what owns individual mortgages. AND SO THE SECURITIES SIT - WAITING… FOR WHAT?

These securities are what is choking the system; nothing is moving.
Equity loans are dead. Securitization is dead. Home loans go to only to people with perfect credit scores and bright earning futures.

NOW YOU KIND OF SEE WHERE A GOOD THING TURNED REALLY, REALLY BAD.