Financial securitization and risk maximization reached peak bananas during the 2008 financial crisis, thanks to the creation of collateralized mortgage obligations (CMOS). Securitization has been a dirty word for a decade, but Wall Street is still finding ways to bundle loans and create more products for income-starved investors due to the Fed’s Zero Interest Rate Policy (ZIRP).
Collateralized loan obligations are similar to (CMOs), but consist of different types of loans, and originate from other sources. In this case, CLOs usually take company and banking loans and put them into bonds that provide different risks and rewards. Designers and sellers of CLOs tell wealthy investors that they can obtain double-digit incomes, that these instruments perform well even when interest rates rise, and that they originate from companies that have low default rates.
Of course, that was the same pitch for CMOs, until people started building products that were constructed with crappy loans and higher default likelihoods. So, once managers run out of loans of higher-rated business loans to collateralize, they could start tapping into loans with higher default risks and higher likelihood of losses. It’s probably already happening.
In 2018, a Federal judge lifted a “skin in the game” rule that forced financial firms to own a share of their risk. A Dodd-Frank rule had made CLO assembly more expensive and forced banks to own a stake in the bonds they created to prevent them from bundling risky loans.
No such rule now exists.
So, if there are more risky loans bundled and a corporate bond crisis ensued, a lot of these things would then...implode. If there’s one thing we know about Wall Street, it’s that greed has no memory.
Now, run. Tell no one. Start burying money in the walls.
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Finance: What is Collateralized Mortgage...65 Views
Finance a la shmoop what is a collateralized mortgage obligation or
CMO all right people well this is a GMO and this is a CMO yeah it's a bunch of
mortgages in one investment vehicle pot like mortgage Stone Soup not nearly as [Mortgage stones in a bowl of soup]
exciting is that that man-eating plant over there
so yeah just a bunch of mortgages that are packaged together when banks and
investors package mortgages together well they can treat them like they're a
big fat indexed bond fund because these groups of mortgages while they pay
interest ie the interest comes from the people who are actually paying off their
mortgages so why would you collateralize a mortgage obligation anyway answer risk
by packaging lots and lots of mortgages together the theory was that well as a [CMO boxes on a conveyor belt]
whole they would create a much less volatile environment than the former
alternative of having tens of thousands of individual mortgages many of which at
any given time were you know in do rest as people were dead beating and not [Man playing video games]
paying what they promised to pay back right well collateralizing this group
meant simply placing all of them into one investment vehicle that could be
bought and sold as if it were in ETF or individual closed end fund but Wall
Street being Wall Street where greed is good until it's not abused the notion of [Boxing gloves punch collateralized]
collateralized mortgages and actually applied the notion of collateral against
them pledging as collateral the equity in these mortgages or packages of
mortgages and then borrowing against them so it's like leverage on leverage,
highly volatile and this is sort of like the brilliant idea of the fraternity [Man walking along]
social chairman sending the pledges to get graham crackers marshmallows and
chocolate when he sees his you know couch is on fire yeah like why wouldn't [People carrying snacks and a couch on fire appears]
he just put it out like what was he imbibing there all right well in fact
this is more or less what happened in the mortgage meltdown of 2008 and 9 and
it was helium inside of the couch that exploded in the form of many of these [Helium explodes on a couch]
mortgages becoming insolvent and as one mortgage went bad
well it caused a chain reaction of panic up and down the economic food chain
which resulted in the near bankruptcy of the United States financial system
basically the people who pulled together these CMOS forgot what the O stands for [Man walking along the street and plant eats him]
oh dear, oh my
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What is collateral? Any type of asset or property that a borrower pledges as security for a loan is classified as collateral. As the lender has a c...