By this point, I am sure everyone has heard of the "Sub-prime Mortgage Crisis" and how stupid pundits are screaming about the end of the world. Well, as usual, it ain't.
If you are anything like me, you've been seeing this story floating around for months now, and kept a vague interest in it because it seems kind of important and interesting, but have been utterly frustrated by the fact that most of the coverage barely even attempts to actually explain what is going on. Reporters constantly mention things like "Collateralized-Debt Obligations (CDO's)" and then briefly mutter something about this being an obscure, complicated financial instrument. I have even found this to be the case in my favorite magazine, The Economist (although I found this an interesting article on risk-assessment), which as its name suggests has much better business, finance, and economics coverage than almost any other major news outlet.
So, imagine my excitement when I found this brilliant little interactive feature linked from Matthew Yglesias' blog that will give you a pretty good idea of what a CDO is in about 2 minutes. Then, based on the comments from that blog post, I read this very interesting article which does a much more thorough explanation (it's long and not for the faint-of-heart, but I dig this shit).
The summary, as best I understand it, goes something like this: First, banks loan out a crapload of mortgages. Then, they bundle them together to sell to someone else. However, they divide the sale up into "tranches" where the highest tranches pay out first and have the lowest risk, and the lowest tranches pay out only if the higher tranches pay out, and so have a higher risk. That all makes perfect sense and is not where the trouble lies. The problem is that no one wanted to buy the lowest tranches - so these then got bundled together and re-tranched - this re-tranching is what makes a CDO. So again, the highest CDO tranches pay out first and were thought to be low risk, and all the risk was thought to lay in the lowest tranches. But since the CDO is composed entirely of high-risk assets, even the highest tranches of the CDO are pretty risky. But apparently, no one figure that out until now. So banks and others are holding onto these highest CDO tranches, having been told that they are low-risk, but since all they are composed entirely of high-risk assets that are not paying out, they now are not worth shit and people are losing a shit-ton of money. Since most of the CDO's not paying out are based on 'sub-prime mortgages', we have the infamous 'Sub-prime Mortgage Crisis'.
Wednesday, December 12, 2007
Subscribe to:
Post Comments (Atom)
2 comments:
Interesting bit on the "tranches." Of course, none of that changes the fact that the banks originally gave out loans to very high risk borrowers and that the borrowers accepted loans they knew (or should have known) they would have a difficult time handling. To me, those are fundamentally the reasons we're in this "sub-prime crisis" as it's called.
Yeah, that's a slightly more informed version of my understanding of it. I heard there was an issue with the liquidity of these instruments too. Like, if someone wanted to get cash for the instrument, but nobody's buying them because of the "crisis", that makes people accept less money for them, which makes other similar instruments worth less, and makes the crisis worse. But...you may have said that in fancier language than I know!
Post a Comment