I received an email from a financially astute friend who described the sub-prime fiasco in an unusual way.
Let me relate it to you.
You will probably know more than the politicians in Washington after you’re done.
Once upon a time, a borrower went to a mortgage broker and said, “I need a loan, however, I need a low interest rate and my employer won’t verify my employment. Oh, and I have marginal credit and do not have a down payment. Is that a problem?”
“No,” the lender said, “we have a liar’s loan, or a sub-prime loan, where you can verify your own income and employment, get a low interest rate and we will increase it later.”
The borrower said, “You guys are awesome.”
The lender responded, “It is no big deal, we don’t really lend you the money, a bank does, and we get a commission.”
At the bank a few weeks later, the banker said, “Whoa, we have some really stinky mortgage loans.
Thankfully, the really smart people on Wall Street will buy them and perform their financial magic.”
A few weeks later, the really smart people on Wall Street said, “Uh-Oh, we better get rid of these stinky mortgages we bought, they are starting to attract flies.”
The underling asked, “But, boss, who would buy this junk?” The boss said, “I’ve got it! We’ll create a new security and use these stinky mortgages as collateral.
“We will call them CDO’s or CMO’s. We can sell them to investors and promise to pay them back as the mortgages are paid off.”
The underling responded, “But junk is junk. I don’t get it.” The boss replied, “Sure, individually they are junk, but we will pool them together and only some of them will go bad.”
The underling still did not get it, so the boss explained further; “The new CDO will be made up of three pieces.
“We will call them the good, the not-so good, and the ugly loans.
“If and when some of the mortgages fail, we will promise to pay investors holding the good first, the not-so-good second and the ugly last.”
“I get it,” said the underling. “The good investors will get paid a lower interest rate, the not-so-good a better interest rate, and the ugly, a big, fat, interest rate.”
“Exactly,” said the boss, “and it gets better. We will buy bond insurance for the good and that way we can get a AAA rating on the packages.
“On the not-so-good, we can get a BBB rating. We won’t bother on the ugly package.
“What we will have done, is managed to create AAA and BBB securities out of a pile of stinky, risky mortgages.”
“Boss, you’re a genius,” said the underling, “now who are we going to sell the three pieces to?”
“Well,” the boss said, “those idiots at the Securities and Exchange Commission won’t let us sell this stuff to widows and orphans, so we will sell it to sophisticated institutional clients, like insurance companies, banks, small towns in Norway and school boards.
“In other words, anyone who is looking for a high-quality, safe investment.
“And the good part is, we will keep the ugly piece and pay ourselves a handsome rate of interest.
“In addition, we can put the ugly piece in an off-shore account and it won’t show up on our books.”
Several months later, the administrator of the Norwegian Villagers Pension Fund (NVPF) called the boss at the Investment Bank and asked why they weren’t receiving their monthly payments.
The boss told him that unfortunately, people were not paying their mortgages.
The NVPF administrator said, “Wait a minute, we bought the AAA rated good piece. We were supposed to be paid first.”
The boss replied that the loans were worse than had been thought and he was disappointed also.
The NVPF administrator replied, “But you told me housing prices always go up and your borrowers could refinance.”
The boss replied, “Sorry, we screwed up.”
The administrator replied, “But what about the AAA rating from the agencies?”
The boss replied, “They screwed up, too.”
The desperate administrator asked, “But this security was insured?”
The boss replied, “Are you kidding? The insurers have no money set aside for this, they screwed up too.”
The administrator asked, “What am I to tell our villagers?”
The boss casually replied, “Tell them you screwed up.”
Let’s hope someday soon, we will all live happily ever after after this nightmare is over.
Ray Pugel is a designated broker for Coldwell Banker Bishop Realty. Contact him at (928) 474-2216.