The Subprime Primer

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Slide 1: 

The Subprime Primer - Found in the Blogosphere and Adapted for Presentation

Slide 2: 

At the Mortgage Broker’s…

Ace Mortgage Brokers“We Make Your Dreams Come True” : 

Ace Mortgage Brokers“We Make Your Dreams Come True” Gee, I’d like to buy a house but I haven’t saved any money for a downpayment and I don’t think I can afford the monthly payments. Can you help me? Sure! Since the value of your house will always go up, we don’t need downpayments anymore!

Ace Mortgage Brokers“We Make Your Dreams Come True” : 

Ace Mortgage Brokers“We Make Your Dreams Come True” And, we can give you a really, really low interest rate for a few years. We’ll raise it later, but don’t worry, you can refinance out of it, okay? Sure, no problem. Umm, there’s one other thing…my employer is a real prick and might not verify my employment. Would that be a problem? Nope. We can get you a special “Liar’s Loan” and you can verify your own employment and income!

Ace Mortgage Brokers“We Make Your Dreams Come True” : 

Ace Mortgage Brokers“We Make Your Dreams Come True” You guys are awesome! You are really willing to work with guys like me. Well, we don’t actually lend you the money – a bank will do that – so we don’t really care if you repay the loan. We still get our commission. Wow! Let’s get started!

Slide 6: 

A Few Weeks Later, at the Bank…

First Bank of Bankland, Inc.“Open Your Christmas Club Account Today” : 

First Bank of Bankland, Inc.“Open Your Christmas Club Account Today” I’d better get rid of these crappy mortgage loans. They are starting to stink up my office. Thankfully the really smart guys in New York will buy them and perform their financial magic! I’ll call them right away! NEW MORTGAGE FILE

Slide 8: 

Let’s See What the Smart Guys Are Doing…

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Phew!!! We’d better get rid of these crappy mortgages before they start attracting flies.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” But who would buy this crap, Boss?

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” I’ve got it! First, we’ll create a new security and use these crappy mortgages as collateral. We’ll call it a CDO (or maybe a CMO). We can sell that CDO to investors and promise to pay them back as the mortgages are paid off.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” But crap is crap, isn’t it? I don’t get it.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Sure, individually these are pretty crappy loans, but if we pool them together only some of them will go bad – certainly not all of them. And since housing prices always go up, we really have very little to worry about.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” I still don’t get it.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” The new CDO will work like this: It will be made up of three pieces (or “tranches”) and we’ll call them the “Good”, the “Not-So-Good” and the “Ugly”.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” If some of the mortgages fail, as surely some might, we will promise to pay investors holding the “Good” tranche first. We’ll pay the “Not-So-Good” investors second, and the “Ugly” investors last.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” I’m starting to get it. And because the “Good” investors have the least risk, we’ll pay them a lower interest rate than the other guys, right? The “Not-So-Goods” will get a better interest rate and the “Ugly” will get a nice fat interest rate.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Exactly. But wait, it gets better. We will buy bond insurance for the “Good” piece. If we do that, the rating agencies will give it a really great rating, in the AAA to A range. The will likely give the “Not-So-Good” piece a BBB to B rating, still pretty good. We won’t even bother asking them to rate the “Ugly” piece.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” So you have managed to create AAA and BBB securities out of a pile of stink, risky mortgage loans. Boss, you are a genius. Yes, I know.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Okay, now who are we going to sell the three pieces to?

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Well, the SEC won’t let us sell this stuff to widows and orphans, so we’ll sell it to our sophisticated institutional clients. Like who?

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” Like insurance companies, banks, small towns in Norway, school boards in Kansas – to anyone who is looking for a high-quality safe investment.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” But surely nobody would buy the “Ugly” piece, would they? Of course not – nobody is that stupid. We will keep that piece and pay ourselves a handsome interest rate.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” This is all great, but since we are only using the smelly mortgages as collateral on an entirely new security, we haven’t really gotten rid of them. Don’t we have to show them on our balance sheet?

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” No, of course not. The guys who write the accounting rules allow us to set up a shell company in the Cayman Islands to take ownership of the mortgages. The crap goes on their balance sheet, not ours. The fancy name for it is “Special Purpose Vehicle” or SPV.

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” : 

RSG Investment Bank of Wall Street“Trust the ‘Really Smart Guys’ for All Your Investment Needs” That’s great, but why would they let us do that, aren’t we just moving our own crap around? Sure, but we have convinced them that it is vitally important to the health of the U.S. financial system that investors not know about these complex transactions and what is behind them.

Slide 27: 

Let’s drop in to see the Accountants…

Office of the Czar of Accounting“No Nit Too Small to Pick” : 

Office of the Czar of Accounting“No Nit Too Small to Pick” Sir, as an investor and concerned citizen, I demand that you force our financial institutions to show greater transparency and openness in their financial reporting!

Office of the Czar of Accounting“No Nit Too Small to Pick” : 

Office of the Czar of Accounting“No Nit Too Small to Pick” You again???

Slide 30: 

Gee, We Never Saw it Coming…

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Hey man, what is going on over there? We’re not receiving our monthly payments!

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Yeah, I meant to call you about that, but it’s been really crazy around here. It seems that the guys who took out the mortgages backing your CDO aren’t able to pay them off.

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Wait a minute! We bought the AAA “Good” piece of the CDO. You know? The safe one. We’re supposed to be getting paid first.

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Well unfortunately, the loans were quite a bit crappier than we originally thought and there is very little cash coming in. Frankly, I assure you that we are as disappointed as you are.

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank But you told me that housing prices always go up and that your borrowers could always refinance their mortgages!

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Yeah, that was a bad assumption. Sorry!

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Bad assumption my frigid Norwegian bottom! What about the AAA rating from the agencies?

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank They screwed up too.

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank But this security was insured! What about the insurers?

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Are you kidding? There’s no way they have enough money set aside to cover this mess.

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Well, that’s just great. What am I supposed to tell my villagers?

Norwegian Village Pension Fund : 

Norwegian Village Pension Fund RSG Investment Bank Tell them you screwed up.

Slide 43: 

The End

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