The most interesting thing in that article was barely mentioned...
"Many of the subprime mortgages had been financed through the securitization market, where a wondrous financial alchemy enabled risky investments to be transformed into supposedly safe investments rated AAA by the bond rating agencies, whose calculations of maximum possible losses turned out to have been woefully low."
I wrote a blog about how this is done, at least as it was explained to me. As I mentioned in a previous post, it is very complicated and I'm sure that there is more to it than that, but the point is that it should never be able to happen. It should be impossible to take subprime loans with little chance of having anything repaid (the worst of them) and get them rated AAA. It reminds me of the Arthur Andersen seal of approval on Enron.
It is kind of hard to blame "greedy" investors for purchasing AAA rated MBSs or CDOs. It's not like they were gambling on CCC rated CDOs that were sold as risky, but high yield investments. They were supposed to be secured by mortgages, which would allow the investors to sell the collateral and recoup their investment in the event of default. Many pools may have even been subject to buy-back agreements if defaults were particularly high. Unfortunately, the loans often exceeded the value of the collateral and when it was time for the lenders to buy-back bad loans, they were going out of business left and right.
I think the rating agencies have some explaining to do, along with the lenders. They both need to get things straightened out to win back the trust of the investors. And, I expect the financial companies will be a bit more cautious buying pools of MBSs and CDOs in the future too.
Best,
Robert A. Franco
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