Subprime mortgages were mortgages that were issued to “subprime borrowers” or individuals with a low credit score. In return, they would be charged a higher interest rate. The subprime mortgage market came about in 1992, when Congress passed a bill where Fannie Mae and Freddie Mac were assured a line of credit from the Treasury and exempt from taxes. Congress insisted that both Fannie and Freddie commit a portion of their portfolio to lower-income housing, although it was not sound or secure. Then, ContiMortgage assembled a pool of junk mortgages and convinced rating agencies that the pool as a whole was a grade A investment. The money flowed out to investors that were holding the bonds. ContiMortgage only thought that the loss on the pool as a whole would only be 15%. When CDOs were thrown into the mi in the early 2000s, it made the structure of these bonds even more complex. According to the book, the “US housing market, instead of responding to the supply of homes, or to the income of home buyers, was hijacked by the whims of global investors”
Which investment banks were the big players in the mortgage securitization business? Why did they like it so much?
In the beginning, one of the largest players was a mortgage specialist, Countrywide. But by the end, the largest players were banks such as Wachovia, Golden West, Wells Fargo, Citibank, and Bank of America., Washington Mutual. Along with Goldman Sachs, Merrill Lynch, and other investment banks. Washington Mutual was pressured to write loans, and were grilled on the details of loans when they failed to close and were criticized for making inquiries of applicants, even if it were for the good of the branch and its equity. Goldman Sachs was one of the least-affected banks, but lost a third of its market value. Lehman brothers profited from both residential mortgages and commercial property loans, and handled every aspect of real estate finance. Lehman were turning groups of subprime mortgages into securities; the underlying risk would be held by investors rather than the banks. Investment banks could bundle loans for Fannie and Freddie or shop them to a “private label” firm like Lehman. Lehman would then keep a portion of each of these securities. These risky mortgages were driving Wall Street’s growth. Lehman would take a mortgage pool to Moody’s and only paid the fee if it was please with the rating it received. Bears Stearns and Morgan Stanley were rivals to Lehman. These companies realized that manufacturing CDOs was more lucrative than underwriting stocks and bonds. AIG also took part in the mortgage securitization business. Goldman and Merrill paid an upfront fee for AIG to guarantee the value or a security or CDO.They made money off of the fees generated by selling those mortgages, packaging those mortgages into bonds, selling those bonds to investors, and profited from the spread on the high yields of the the significant portion of the securities they retained.
How does the book describe the attitude of investment bankers to the deterioration in the mortgage securitization business in 2006 and early 2007?
In 2006, the CDO production reached $225billion. And half of these CDOs being produced were said to be synthetic. By mid-2006, the end of the housing bubble was coming to an end, but states how the banks continued to raise the stakes. Banks such as Citigroup still believed that the CDOs were risk-free, and continued to layer risk upon risk.