We all know about the predatory lending practices which produced loans to people who really couldn't manage to pay for them once the rates adjusted, but I wonder how many of these loans would have been made if there had not been a huge demand for High rate Collateralized Debt Obligations. (the sub-Prime mortgages paid higher rates to the lender but also brought higher risk).
Wall street banks were finding a strong market among institutional investors for CDOs. But the high rate tranches of CDOs were composed of higher risk loans. How could the Wall Street Banks sell these to institutional investors who were constrained by their fiduciary duty the funds contributors to not bet their money on risky investments. Pension funds are restricted to investing in triple A rated debt. How could the investment bankers sell the higher returns of the higher risk CDO tranches to institutional investors limited to low risk investments.
Well, the legalization of Credit Default Swaps (CDS) (
CFMA) would have provided an ideal answer to this quandary. They could offer the Higher return CDOs to the institutional investors and also sell them a CDS which would provide
perfect protection from default of the underlying mortgages! What a deal.. the investor would get the sweet returns of a higher rate CDO but with
none of the risk thanks to the Credit Default Swap. IF the underlying mortgages were to default the CDS protects the investor from losing his investment. ... Or so goes the rationale.
I would think such an arrangement would be a powerful selling point to a pension fund manager trying to get higher returns yet being very wary of any additional risk. Collaterized Debt Obligations were big money makers for the Wall street investment banks. IF you could just eliminate the risk associated with the higher return CDOs you could sell gobs of these things.
There certainly was a hot market for CDOs and that would have created a surging demand for higher rate Collateralized Debt Obligations - those based on
sub-prime loans that is.
I just wonder if the legalization of the Credit Default Swap didn't ignite the sub-Prime mortgage market and drive mortgage brokers and other predatory lenders to beat the bushes for anybody they could sign up to a mortgage - whether or not they were able to pay for it in the longer run.
I guess that's why Mother Jones called Phil Gramm
Foreclosure PHil.
"Years before Phil Gramm was a McCain campaign adviser and a lobbyist for a Swiss bank at the center of the housing credit crisis, he pulled a sly maneuver in the Senate that helped create today's sub-prime meltdown."