Mortgage-backed securities: "Who buys this crap?"

[Nords]

Originally Posted by audreyh1

It's a pretty shocking article. Someone will be left holding the bag when mortgage holders default. Will it really just be the hedge funds and pension funds? I kind of doubt it.
I don't understand how people can be allowed to take on mortgages under these circumstances!

Audrey's comment was on my mind when I stumbled across this "Investment Advisor" article.

Here's their rosy sales pitch outlook on the sector: "Moreover, with declines in construction spending and new housing sales, new mortgage applications and refinancings will likely decline—thereby, creating a tighter supply and increasing their value as investments." Then they recommend a few mutual funds who invest heavily in MBSs.

So I guess it's not just institutions, pensions, & hedge fund managers-- it's us, too...

[wabmester]

I've read that banks don't really shed their risk when they bundle high-risk loans into a CMO. They apparently have to make some reps about the default rate, and if defaults go higher, the bank has to buy the loans back.

[brewer12345]

Just about every bond fund in the US owns some MBS. Most of this paper is very, very high quality, typical Aaa and Aa-rated stuff. It is a way for bond fund managers to have something besides treasuries (safe, but low yielding) and corporates (less safe, but higher yelds) but which is unlikely to increase credit risk. The trade off is that you take some risk on teh exact timing of cash flows (extension/refi risk).

When a pile of mortgages is stuffed into a securitization structure, there is a hierarchy of who gets paid first. The top layers comprising most of the value are squeaky clean as far as credit quality goes. By the time you get to the bottom tranches, they can be moderately to extremely risky junk, depending on the riskiness of the underlying loans. Sometimes banks are able to sell this "B piece" or "equity tranche" off to outside investors who specialize in this sort ofthing. Sometimes they keep the B piece and hold it on their books at a small value number. The bank regulators make them treat equity tranches as toxic waste for regulatory capital purposes, so most banks don't hold much of this stuff.

[FinanceDude]

Originally Posted by brewer12345

Just about every bond fund in the US owns some MBS. Most of this paper is very, very high quality, typical Aaa and Aa-rated stuff. It is a way for bond fund managers to have something besides treasuries (safe, but low yielding) and corporates (less safe, but higher yelds) but which is unlikely to increase credit risk. The trade off is that you take some risk on teh exact timing of cash flows (extension/refi risk).

When a pile of mortgages is stuffed into a securitization structure, there is a hierarchy of who gets paid first. The top layers comprising most of the value are squeaky clean as far as credit quality goes. By the time you get to the bottom tranches, they can be moderately to extremely risky junk, depending on the riskiness of the underlying loans. Sometimes banks are able to sell this "B piece" or "equity tranche" off to outside investors who specialize in this sort ofthing. Sometimes they keep the B piece and hold it on their books at a small value number. The bank regulators make them treat equity tranches as toxic waste for regulatory capital purposes, so most banks don't hold much of this stuff.

Great summation, much more eloquent than I was preparing to post......... BTW, remember all those preferreds that were issued with spooky quality high risk stuff underlying them? Wonder what happened to that party??

[Texas Proud]

Like Brewer said...

I used to work with people who did the CMOs... and some had many 100s of traunchs.... The underwriter would go out and ask investors what they wanted and would slice it up and sell them thier request... and MOST of the pool was very safe... if you have the rights to the first cash and only have 30% of the total... well, what is the likelyhood of 70% loss?? Not much..

And there are triggers... some will stop getting interest payments if there is a certain amount of losses.. and some have insurance... again.. as safe as you can get next to Treasuries..