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THE 2007 SUB-PRIME MORTGAGE PROBLEM

This is our analysis of the 12/6/07 article in the NY Times -- "Wary of Risk, Bankers Sold Shaky Mortgage Debt" -- By JENNY ANDERSON and VIKAS BAJAJ
Abstract -- Wall Street firms are coming under scrutiny for their role in selling risky mortgage-related securities to investors. This analysis is our attempt to simplify the article and make it more understandable to the general public

Click here for the original article -- http://www.nytimes.com/2007/12/06/business/06hedge.html?n=Top/Reference/Times%20Topics/Subjects/B/Banks%20and%20Banking

We are hoping that Jenny Anderson and Vikas Bajaj follow with other articles and perhaps a book that explains this problem in depth. In our opinion, the public and Congress are unlikely to truly understand the problem unless the reporting is simplified and more detailed.

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The above referenced article from the NY Times of 12/6/07. It is almost unbelievable.

Here is the last paragraph. "What is clear is that home loans were highly lucrative to Wall Street and its bankers. The average total compensation for managing directors in the mortgage divisions of investment banks was $2.52 million in 2006, compared with $1.75 million for managing directors in other areas, according to Johnson Associates, a compensation consulting firm. This year, mortgage officials will probably earn $1.01 million, while other managing directors are expected to earn $1.75 million." We are talking about serious money.

Summarizing --- In 2006, managing directors in the mortgage divisions of investment banks were each personally making $2.52 million dollars / year on the average ... This year, they will only make $1.75 million / year.

What did they do to earn that money? (A) They purchased large numbers of home mortgages from banks who originally lent the money on those mortgages. (B) They put those mortgages into pools and, (C) they sold "tranches" of the pools to large investors like pension funds, banks, cities and whatever. Read the definition of tranche from my computer's dictionary.

Tranche -- a division or portion of a pool or whole; specif : an issue of bonds derived from a pooling of like obligations (as securitized mortgage debt) that is differentiated from other issues especially by maturity or rate of return.

To simplify -- In other words -- these guys would buy, for instance, a $100,000 mortgage (which is essentially a promise to pay $100,000 at some interest rate over some specified period of time) and sell it (presumably) for more than $100,000. They would keep (earn) the difference (profit) between the purchase price and the selling price.

Question -- Why would the banks who originated the mortgages, sell them?
Answer -- I think it is obvious that selling the mortgages allowed the banks to issue new mortgages (by freeing up their capital). That would allow them to make more money in origination fees. The total of the fees must have been more profitable than the interest on the mortgages.

Question -- Why would the "large investors" buy the shaky mortgages? Shouldn't they have known they were not worth the price?
Answer -- they obviously did not know what they were buying. They were either (A) stupid or (B) misled.

When you consider that the managing directors bought poor quality mortgages and sold them at inflated prices -- you can see how they could have "earned" their enormous yearly income ($2 million / year ++)

Is this "Alice in Bankingland" -- or what?