I have a concern.
Collateralized Debt Obligations (CDOs) have been in the news a great deal in recent weeks linked to the Bailout and the financial situation affecting all of us. CDOs originally were formulated to take whole mortgages, typically in $100,000,000 chunks, ensure the paperwork for each mortgage is spotless, insure each mortgage and apply a triple A rating to the resulting bond. These bonds have been the gold standard for 40 years and have never failed. Around 2000 political pressure to increase homeownership resulted in looser mortgage lending practices through FHA.
So far so good. Looser lending practices resulted in a false boom in prices at the bottom end of the market. The situation wasn't ideal but could be contained. What happened next resulted in the present catastrophe. The Investment Banks on Wall Street were responsible for creating the CDOs from mortgages. That function had always been very profitable. Under the guise of increased home ownership Wall Street relaxed mortgage standards still further, outside the FHA system, and the banks had a field day loaning far more money than they had been used to, collecting up front fees and selling the mortgage paper so they had more money which they could loan again and collect still more fees. Prices were driven higher and higher with ever more relaxed lending standards keeping the whole scheme going. The entire edifice was calculated to increase profits now without regard to future problems. Avoiding future problems is what regulation does and regulation has not been popular lately.
The Bailout news has angered many Americans and infuriated some. With our love of simple solutions I am afraid that mortgage backed CDOs will be outlawed. The original purpose of CDOs was to protect Banks from fluctuations in interest rates and to supply a reliable stream of money to be made available for home purchase. For example if a bank gave you a mortgage for 30 years at 5% and two years later had to pay 8% to its depositors it would instantly go broke. Only through CDOs are US financial institutions able to provide 30 year fixed rate mortgages. No other country has this system and they all use some form of variable rate mortgages. This purpose has been subverted by Cynical Wall Street executives, corrupt Bond Rating agencies and bank executives who were unable to see beyond next quarter's profit projection.
I call upon us all to take a hard look at the whole financial system, eve though it will make your head hurt, throw out the bad, retain the good, jail those who committed fraud and participated in corruption, fire or demote those who demonstrate short term thinking; but please, please do not throw out the baby with the bathwater. Retain responsible mortgage backed CDOs.
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