Thursday, May 24, 2012

All The Devils are Here--Discussion question

#2: “Though a 30-year fixed mortgage may seem simple to a borrower, mortgages come full of complex risks for investors.  30 years, after all, is a long time… part of the answer came from tranching, carving up the bond according to different kinds of risks.  Investors found this appealing because different tranches could be jiggered to meet the particular needs of different investors.”  (p. 8)
            Tranching has obviously changed the nature of the relationship between borrower and lender into a baffling economic reality.  Do you feel that tranching could theoretically possess the redeeming quality of encouraging a greater level of investment in the housing market, or is this merely a ‘quick fix’ scheme and not worth the risk of long-term fallout?

Obviously, this played out to be not worth the long term risk. Anytime someone bundles a bunch of bad things into one, the outcome is not going to be a good thing. In my mind, I see this as taking a bunch of blown up motors and combining them into one motor. It is possible you may be able to make it run, but it is not going to run as long as a brand new motor would. I can see how investors felt comfortable purchasing these tranched mortgages from the banks because it allowed them to get a huge chunk of this booming mortgage market. However, I think they became too confident with themselves and started making poor investments despite the risk. They were making so much money that it was no longer necessary to rate the risk of the investment. This obviously led to a whirlwind of problems and the eventual recession when the real estate bubble burst in 2007-8. 

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