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CDO/ CDS: Systems Based on False Premises
| Date post: | 20-Jun-2015 |
| Category: |
Economy & Finance |
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CDO/ CDS: Systems Based on False Premises
Banks Improved Profits with these 3 Ingredients
Belief Based on 3 Mythical Assumptions
Design Simple Systems that Appear Complicated
AssumedReality
We are all interconnected
The invisible hand: Too Complicated to Control
3 Great Backers Convinced Investors to Invest
AIG: Insured papersCR: Rated favorably papersGovernment: weakened rules and regulations
New attractive product for investors
AIG: Insured papersCR: Rated favorably papersGovernment: weakened rules and regulations
New attractive product for investors
Past: When Your Loss Equaled Only One Loss
When Your Loss, Meant at Most 2 losses
HouseHouse
YouYou
BankBank
Title
Mortgage
Live
If you pay the house in full you get your title
If you cannot pay for it, Bank takes it, and sell it.
Bank starts taking its profit (interest) before the principle.
Maximum number of possible losers in case of default 2.
Bank can sell the title to Freddie Mac, Fannie Mae...
Assumption: fixed rate mortgage
Bank can sell the title to Freddie Mac, Fannie Mae...
Assumption: fixed rate mortgage
You Bank
Rate goes up fixed rate/ fixed costCannot change your
contract
Rate goes Downyou may want to
refinanceLess profit, if you refinance
If you fall behind you payment
May lose your home May be willing to negotiate
Advantagepredictable monthly
expenseKnow your banker
Easy to manage
Disadvantage20% downpaymentHouse/ Income <5
Wait a long time to recuperate profit and
principle
When You Lose, there are two losers
Now: When Your loss Equals The loss of
Many
How You are Reduce from a Customer to a Thing
When you pay your mortgage your payment is distributed to the holders of CDOs.
CDS holders pay a bet to the bank that within a time frame CDOs will not perform.
CDS Holders know who they are betting against.
CDOs holders don’t know who is betting against them.
If too many of us are unable to pay our mortgages CDOs fail.
The insurance of CDOs is sold as CDS.
CDOs are rated by Credit Rating Agencies.
Investors
Investors
HouseHouse
Bank
BankSpeculators
Speculators
CDS
CDOWall
MI
MI
Title
Title
MI: Mortgage InitiatorCDO: Collateral Debt ObligationCDS: Credit Default Swap
MI: Mortgage InitiatorCDO: Collateral Debt ObligationCDS: Credit Default Swap
You MI
Rate goes upYou May not be able
to payMore Money
Rate goes DownLocked in, expensive to change contract
Protected against refinancing
If you fall behind you payment
May lose your home Not its problem
AdvantageInitially: Can afford
more with less income
Sell title and recuperate principle and some profit
DisadvantageSubsequent monthly
mortgage unsustainable
None: sold the title to someone else
Appearance: In the Long Run, you lose MI wins
What we Learned of our Belief from the Financial Meltdown
The New Adjusted Belief
•Income matters when buying a house.•Homeowners will not hold on a falling assets.•Credit rating cannot be trusted.•Houses, like any other assets, can and will fall.•Every bubble bursts.•Homeowners will not starve to pay for their mortgages.
