In Twiddle Dumb and Twiddle Dumber - Part One I talked about reading Michael Lewis's book The Big Short and some of my opinions about the Stock Market and Big Corporations. Some of you that think you know me ought to really see what I have to say.
In these post I want to try and explain what they were doing in the Bond Market and why it was bad. I do not claim an expert knowledge and I am really looking for your feedback and understanding too.
Basically I think we all understand that mortgages get bought and sold after the home loan is made. Well they took it one step further with the bond market.
- Mortgages were backed as a group and sold in bundles. Basically you spread the risk around. If you bundle a bunch of mortgages together and a few go bad it should not hurt too much. Better yet small investors can buy a piece of this mortgage market.
To me this does not sound like a bad idea.
- However, as we have all heard about the Lenders were under pressure to ease lending standards. As we all know a lot of bad mortgages were being made because the Feds wanted them made and the lenders were making money selling them.
This should have been red flag # 1.
- When they package these loans into Bonds (and it may sound hard to believe) most people had no understanding of how bad they were. Even if they knew there were some issues everyone just kind of had an attitude that mortgages had this history of performance that would dictate the future.
Yes they all drove right by Red Flag # 1.
- Once the Bonds were bundled they then sliced the bond into tiers with different levels of risk. Those that took the more sure pay off got lower rates and those with the riskier tiers got a higher right. Apparently this is very complex with many pieces; but they took a pile of crap cut it into pieces and called the bottom crap and the rest cream.
This is why I find it hard to believe no one understood what was going on. Someone planned these tiers in detail.
By Now You are Bored and not Reading in Detail - Well Guess what that is how this problem happened people stopped paying attention and were just happy to be making money!
Take a break and I will pick this up in Part 3.